Borrowing Culture and Debt Relief: Evidence from a Policy Experiment

beSpacific 2014-02-17

De, Sankar and Tantri, Prasanna L., Borrowing Culture and Debt Relief: Evidence from a Policy Experiment (February 15, 2014). Available at SSRN: http://ssrn.com/abstract=2396368

“Using a model as well as extensive empirical tests, the present paper investigates the effects of a large-scale debt waiver program on the post-waiver debt repayment behavior of borrowers in a typical rural credit market in an emerging economy. In this market the farmers borrow from banks at a subsidized rate and from private moneylenders at a substantially higher rate, debt contract enforcement is imperfect, and political interventions in the credit market in the form of waiver of overdue debt can happen even in normal states of the economy. Our model includes all classes of borrowers: those who receive full debt relief, those who receive partial debt relief, and those who do not benefit at all from the program as they do not have overdue loans. The effects are negative for all groups. In the post-waiver period, all borrowers, behaving strategically, default as well as take longer to repay their loans than in the pre-waiver period, causing ex-post inefficiency in the credit market. Interestingly, the effects are most negative for the formerly good borrowers who did not default before. Expectations about similar debt relief in future coupled with extensions on loan repayment granted by bankers who find debt recovery difficult drive our results. Further, rationally anticipating adverse borrower behavior, the lending institutions ration credit, generating ex ante inefficiency as well. Ironically, access to credit declines for poor households following unconditional debt relief. We confirm the predictions of the model with extensive tests using loan accounts data for a large sample of rural borrowers before and after a nation-wide debt relief program undertaken by the Indian government in 2008, one of the largest such programs in history.”

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