IFPRI RESEARCH REPORT 116 Access to Credit and Its Impact on Welfare in Malawi Aliou Diagne Manfred Zeller INTERNATIONAL FOOD POLICY RESEARCH INSTITUTE Access to Credit and Its Impact on Welfare in Malawi Aliou Diagne Manfred Zeller Research Report 116 International Food Policy Research Institute Washington, D.C. Access to Credit and Its Impact on Welfare in Malawi Aliou Diagne Manfred Zeller International Food Policy Research Institute Washington, D.C. Access to Credit and Its Impact on Welfare in Malawi Aliou Diagne Manfred Zeller International Food Policy Research Institute Washington, D.C. Copyright © 2001 International Food Policy Research Institute All rights reserved. Sections of this report may be reproduced without the express permission of but with acknowledgment to the International Food Policy Research Institute. Library of Congress Cataloging-in-Publication Data Diagne, Aliou. Access to credit and its impact on welfare in Malawi / Aliou Diagne, Manfred Zeller. p. cm. — (Research report ; 116) Includes bibliographical references. ISBN 0-89629-119-7 (pbk.) 1. Rural poor—Malawi. 2. Agricultural credit— Malawi. I. Zeller, Manfred. II. Title. III. Research report (International Food Policy Research Institute) ; 116. HC935.Z9 P614 2001 332.7′1′096897—dc21 00-054679 Contents List of Tables iv List of Figures vi Foreword vii Acknowledgments viii Summary x 1. Introduction 1 2. The Rural Economy and Microfinance Institutions in Malawi 6 3. Survey Design and Description of the Data 16 4. Econometric Analysis of the Impact of Access to Credit on Household Welfare 62 5. Results of the Econometric Analysis 81 6. Conclusions and Implications for Policy 123 Appendix: Econometric Methodology 130 References 143 iii Contents Tables 1. Loan disbursements and recovery rates of the Malawi Rural Finance Company 12 2. Demographic characteristics of households 20 3. Asset ownership, composition, and distribution 21 4. Asset ownership, composition, and distribution by credit program membership 24 5. Loan transactions and their characteristics 27 6. Distribution of formal and informal credit limits and unused credit lines, October 1993–December 1995 28 7. Households with access to credit, by program membership and sector of the credit market 34 8. Major rainfed crops grown, by household 37 9. Household cultivated land and its allocation among crops in the 1994/95 season, by credit program membership 38 10. Fertilizer acquisition and relative importance of different methods of acquisition and source of financing of inputs in the 1994/95 season, by program membership 40 11. Distribution of fertilizer among crops in 1993/94, 1994/95, and 1995/96 seasons, by program membership and type of farm 42 12. Average yield and net income per hectare for major rainfed crops, 1994 production year, by program membership 44 13. Average yield and net income per hectare for major rainfed crops, 1995 production year, by program membership 45 14. Fertilizer recommendations for maize and tobacco in Malawi 47 15. Total household farm and nonfarm income, 1994 and 1995, by credit program membership 54 16. Consumption expenditures, calorie intake, and nutritional status, by credit program membership, 1995 58 17. Regressors used in equations 75 18. Definition and summary statistics of variables used in the model 82 iv Tables 19. Predicted conditional probability choices 85 20. Determinants of program participation: Parameter estimates and partial changes in probability of participation resulting from marginal changes in selected independent variables 86 21. Formal credit limit equation: Estimated parameters and partial effects of marginal changes in selected independent variables 89 22. Informal credit limit equation: Estimated parameters and partial effects of marginal changes in selected independent variables 91 23. Formal credit demand equation: Estimated parameters and direct and indirect partial effects of marginal changes in selected independent variables 94 24. Informal credit demand equation: Estimated parameters and direct and indirect partial effects of marginal changes in selected independent variables 96 25. Annual income equation: Estimated parameters and partial effects of marginal changes in selected independent variables 102 26. Crop income equation: Estimated parameters and partial effects of marginal changes in selected independent variables 104 27. Nonfarm seasonal income equation: Estimated parameters and partial effects of marginal changes in selected independent variables 106 28. Food expenditure equation: Estimated parameters and partial effects of marginal changes in selected independent variables 112 29. Daily calorie intake equation: Estimated parameters and partial effects of marginal changes in selected independent variables 114 30. Daily protein intake equation: Estimated parameters and partial effects of marginal changes in selected independent variables 116 31. Weight-for-age Z-score equation: Estimated parameters and partial effects of marginal changes in selected independent variables 118 32. Height-for-age Z-score equation: Estimated parameters and partial effects of marginal changes in selected independent variables 120 v Figures 1. Location of the DRD/IFPRI Rural Finance Survey sites 17 2. Distributions of formal and informal credit limits and unused credit lines for all respondents, October 1993–December 1995 30 3. Distributions of formal and informal credit limits and unused credit lines when a formal loan was granted, October 1993–December 1995 31 4. Distributions of formal and informal credit limits and unused credit lines when an informal loan was granted, October 1993–December 1995 32 5. Distributions of formal and informal credit limits and unused credit lines when a loan demand was rejected, October 1993–December 1995 33 6. Distribution of formal and informal credit limits when no loan was requested, October 1993–December 1995 36 7. Yields of local maize, hybrid maize, and tobacco versus fertilizer use 48 8. Gross margins of local maize, hybrid maize, and tobacco versus fertilizer use 49 9. Yields of local maize, hybrid maize, and tobacco versus total input cost 50 10. Gross margins of local maize, hybrid maize, and tobacco versus total input cost 51 vi Figures Foreword F or decades the poor in developing countries (and elsewhere) were essentially shut out of credit and savings services. Because the poor did not meet the tradi- tional criteria for borrowing, financial institutions perceived them as bad credit risks. More recently, development practitioners have come to see that the poor can indeed make effective use of credit to raise their incomes and get access to more food and other necessities. In fact, in some quarters microcredit is now seen as the solution to poverty. Research conducted at IFPRI shows, however, that although credit can be an important tool in the fight against poverty, credit alone cannot be guaranteed to raise incomes, increase food security, and improve nutrition. In this research report, Aliou Diagne and Manfred Zeller examine the case of Malawi, where several institutions offer credit to poor, smallholder farmers to allow them to buy fertilizer, seeds, and other inputs for growing maize and tobacco as a way of helping raise incomes. Surprisingly, they find that farmers who participated in these credit programs ended up with less net crop income than those who did not. Their results make clear that the conditions surrounding credit programs must be right—that is, they must reflect the actual opportunities and constraints faced by poor farmers—for credit to work effectively. For example, credit is not of much use in sit- uations in which farmers have little access to roads, markets, health care, and com- munications infrastructure and are subject to drought that can wipe out their crops, as is the case in Malawi. This research report reveals how complicated the task of effective rural develop- ment can be, but it also points to concrete steps, in addition to offering credit ser- vices, that governments and development organizations can take in their efforts to eradicate poverty and food insecurity. This research report should be of great signif- icance to anyone interested in how rural finance can be made to work best for those in the most need—the poor and food insecure in developing countries. Per Pinstrup-Andersen Director General vii Foreword Acknowledgments O ur special gratitude goes to the members of the survey households, who dur- ing three survey rounds in 1995 gave of their precious time and who responded to numerous questions, some of which touched on very sensitive issues, such as their possession of assets, access to credit, and level of debt. We thank them for their trust and their contribution to what is essentially a public good that does not create any direct and immediate benefit for them. It is our hope that this report—in conjunction with prior reports, papers, policy summaries, and workshop proceedings dissemi- nated in Malawi by the rural finance research program of Bunda College and IFPRI—will be effectively used by policymakers to improve the economic opportu- nities for and therefore the welfare of rural households in Malawi. This research report and the underlying field research and data processing would not have been feasible without the essential and invaluable contribution of the re- search staff of the Bunda College of Agriculture, University of Malawi, and without the contribution of many others in Malawi, at IFPRI, and at other institutions. Fore- most, we are grateful for the assistance of the staff of the Department of Rural De- velopment (DRD) who contributed to the successful implementation of the field sur- vey, data cleaning, and data analysis for the DRD/IFPRI Rural Finance Study. We thank Karid Chirwa, Tyme Fatch, Swalley Lamba, Samson Manda, and Franklin Simtowe, who provided invaluable research and administrative assistance. We espe- cially thank Franklin Simtowe for his excellent research contribution to the in-depth descriptive analysis for this report, Dr. Alexander Phiri for helpful discussions dur- ing all phases of the research project, and Dr. Todd Benson for contributing critical comments and questions that sharpened the analysis presented here. We also enjoyed working with a number of students at Bunda College, notably Vinda Kisyombe, Mary Mandambwe, and Hardwick Tchale, who used the DRD/IFPRI Rural Finance data set for their M.Sc. research and who provided additional insights for the role of credit in rural development. Our utmost gratitude goes to Dr. Charles Mataya, whose sup- port as head of the Department of Rural Development made this collaboration pros- per over time. We thank Dr. Malcolm Blackie and Dr. Bharati Patel of the Rockefeller Founda- tion in Malawi for their encouragement during the course of the project. At IFPRI viii Acknowledgments [...]... geared toward income generation, and in particular toward the growing xi of fertilized hybrid maize and tobacco, access to the type of credit products offered in Malawi is expected to have mostly indirect effects on consumption and nutrition through its potential effect on income The rural financial institutions in Malawi covered in this study do not offer financial products, such as consumption credit and. .. often confused with participation in formal credit programs Indeed the two concepts are used interchangeably in many studies However, to analyze satisfactorily the socioeconomic determinants of both access to credit and participation in formal credit programs and to assess their respective impacts on household welfare outcomes, one needs to make the distinction between access to credit (formal or informal),... participating in formal credit programs still have binding credit constraints However, Malawian households would borrow on average only about half the amount of any increase in their credit limits The level of interest rates charged on loans seems not to be an important factor for households in deciding in which microfinance institution to participate Nonprice attributes of credit institutions and their... The second pathway through which access to credit affects household welfare is by increasing a household’s risk-bearing ability and by altering its risk-coping strategy The third pathway—enabling access to credit for consumption smoothing—is closely linked to the second, and we therefore discuss them together because they both affect the resilience of households in bearing production and consumption risks... both its financial and its nonfinancial services The main findings of the study regarding the impact of access to credit on household welfare outcomes do not support the notion that improving access to microcredit is always a potent means for alleviating poverty—an opinion voiced, for example, at the Microcredit Summit in Washington, D.C., in February 1997 Both the tabular and the econometric analysis... econometric analysis of the determinants of households’ access to and participation in informal and formal credit markets, as well as the marginal impacts of access to formal credit on farm and nonfarm incomes, household food security, and nutritional status Chapter 6 considers implications for policy and future research 5 CHAPTER 2 CHAPTER 2 The Rural Economy and Microfinance The Rural Economy and Institutions... can expand and complement rather than substitute for the services offered by the existing informal credit market An important step in obtaining this information is to quantify the extent and determinants of households’ access to both informal and formal credit markets and the degree to which the two forms of credit are complements or substitutes A Definition of Access to Credit Access to formal credit. .. institutions, as well as adequate provisions for loan defaults and the building up of reserves for rescheduling loans, is a necessary precondition for rural financial institutions to prosper and to be able to offer their clientele reliable access to future credit and savings services The necessary resources, infrastructure, and socioeconomic environment are not yet in place for access to formal credit to. .. program was to analyze the determinants of access to credit in Malawi and its impact on farm and nonfarm income and on household food security The study also sought to quantify the relationship between the demand for formal loans and that for informal loans From a policy perspective, such an analysis is important for at least two reasons First, by quantifying the welfare impact of access to financial... government- and nongovernmental organization (NGO)–supported credit programs may crowd out the financial services offered by these informal financial institutions Therefore understanding how the informal institutions serve households’ demand for financial services and interact with the formal credit institutions set up by governments and NGOs is critical in identifying policies, institutional designs, and financial . IFPRI RESEARCH REPORT 116 Access to Credit and Its Impact on Welfare in Malawi Aliou Diagne Manfred Zeller INTERNATIONAL FOOD POLICY RESEARCH INSTITUTE Access to Credit and Its. Credit and Its Impact on Welfare in Malawi Aliou Diagne Manfred Zeller International Food Policy Research Institute Washington, D.C. Access to Credit and Its