Rural credit-based institutions and subsistence consumption: An empirical study based on household data from Nepal

This study uses the data of a three-round survey of 253 households in five villages across Nepal conducted during 1991-1992. It examines ways in which poor households use credit to uphold food consumption during temporary downturns in their incomes, arising either out of seasonal fluctuations in agricultural incomes or because of adverse weather conditions and household-specific illness. This is done by decomposing observed household income into their permanent and temporary parts and estimating the effects of transitory income on food consumption, using a consumption function that includes variables that affect access to credit or other insurance-related institutions. Tests are conducted on whether households that are likely to have superior access to credit are able to better smooth out their consumption patterns. A structural relationship between household characteristics and access to different credit sources is also specified and the extent to which loans from different sources respond to externally generated shocks is estimated using the three-stage least squares technique.It is found that both changes in rainfall and debilitating sickness cause fluctuations in household income levels. The impact of changes in rainfall was greater on household that cultivated bari land (upland). Analysis suggests that poor households respond to temporary declines in their incomes in two ways. First, in order to uphold basic energy intake, they switch from more expensive cereal (rice) to a less expensive one (maize, millet). Second, households also appear to take recourse to borrowing in order to finance basic consumption. It is found that those that lacked access to credit institutions, informal and formal, were more likely to reduce food consumption.Informal sources of finances--friends and relatives, as well as village moneylenders--are far more important than formal sources in enabling households to protect their consumption. Collateral requirements and also the high level of transactions costs involved with doing business with formal institutions make them unsuitable transaction partners in financing the purchase of quickly needed food and other urgent consumption items. A large fraction of credit transactions in the informal sector were between friends, neighbors, and relatives. Dependence on informal finances falls with rising incomes because both the capacity to self-insure basic household consumption and access to formal financial institutions increases with wealth. In fact, there is evidence that richer households have superior access to special programs purportedly targeted to the poor, reminding us that merely setting up special institutions to assist the poor, without built-in organizational or operational incentives to do business with the poor, will often not succeed. The Small Farmers Development Programme (SFDP) in Nepal provides one example of this.