Interest Subvention for Crop Loans in India: Win-Win or Win-Lose

Abstract

Problem Definition: Interest subventions (subsidies) on crop loans are a common feature of rural credit markets in developing countries. This study evaluates the impact of an interest subsidy program for the Kisan Credit Card (KCC) scheme - India’s flagship program to provide short-term agricultural credit. The objective behind giving interest subsidies is two-fold – increasing access to credit and improving loan repayment rates (by offering affordable credit), and is therefore regarded as a win-win for the lender and the borrower. However, the effectiveness of this policy has been debated. Moreover, academic research which causally evaluates the impact of such interest subsidy programs is limited. Methodology/Results: We use a unique transaction-level dataset from a large public sector bank to study a natural experiment in which the state of Odisha introduced a new subsidy program for its farmers in 2013-14. We use a combination of matching and difference-in-differences techniques, utilizing the nuances in the policy implementation. Further, we capture the heterogeneous impact of the policy on new and experienced borrowers. With regard to access to credit, not only do we observe a substantial increase (35%) in new loans but also a 20% decrease in the overall loan amount, indicating increased breadth and depth of access. As against the standard economic theories which posit that interest rate reduction leads to a higher repayment rate on loans (by addressing adverse selection and moral hazard problems), we observe a reduction in odds of repayment to 0.36-0.75 times its original value. Managerial Implications: Our impact assessment reveals unintended consequences of the interest subsidy and will let policymakers evaluate if the access-repayment trade-off is acceptable in their context. Further, the counter-intuitive findings shed light on the importance of various operational and behavioral aspects of the agricultural lending ecosystem, which need to be considered to craft effective, i.e., win-win credit policies.