Agricultural credit to rural finance: Needed paradigm shift for rural development

Friday, 19 June 2020 00:00 -     - {{hitsCtrl.values.hits}}

Rural poverty is mainly linked to the production economy of the heterogeneous rural households. Most farmers do not use modern agricultural technology; their crop choices are not optimal in relation to potential for earning higher incomes in the market; they do not allocate resources at their command efficiently; their productivity is much below the potential – Pic by Shehan Gunasekara


By Dr. Nimal 

A. Fernando

One of the immediate concerns of the Government is ‘revival’ of the COVID-19 battered economy. Beyond this, broader medium-term development objectives include building a prosperous rural economy that can provide a better standard of living for the majority of the rural population and provide support to the rest of the economy. 

The underlying rationale is clear: over 75% (approximately 17 million people) of the population of the country live in rural areas. The informal economy in the rural sector is vast and characterised by low productivity. Density of poverty and near-poverty are high in rural areas. Low level of income of the majority of the rural population drags the country’s average income level down because of the high weight of the sector. Without a thriving rural economy, the rest of the economy will be terminally ill. 

High policy priority to agricultural credit

The policymakers are cognisant of the need to address development issues in the rural sector through a host of policy interventions. And in the financial sphere they have accorded high priority to developing agricultural credit.

The heavy policy accent on agricultural credit is based in part on the current plight of the small farmers: a vast majority of the small farmers and their families remain poor and highly vulnerable to various external shocks. The rural sector is also home to a majority of the extremely poor, multi-dimensionally and near multi-dimensionally poor. And agriculture is considered a fundamental instrument for sustainable development and poverty reduction. Agricultural productivity growth is vital for stimulating growth and development in rest of the economy.

The rural poverty is mainly linked to the production economy of the heterogeneous rural households. Most farmers do not use modern agricultural technology; their crop choices are not optimal in relation to potential for earning higher incomes in the market; they do not allocate resources at their command efficiently; their productivity is much below the potential. And more importantly, the government’s ‘Vistas of Prosperity and Splendor’ document states that “the average farmer has fallen into a debt trap due to informal lenders and high interest micro-credit systems”. To free the farmers from this debt trap and enable them to develop their agriculture, policymakers believe agricultural credit is vitally important.

The importance of agricultural credit is not denied. However, when the policy accent on it is placed in the context of the broader development needs and the structural characteristics of the rural economy, the policy seems to be somewhat flawed. 

Agricultural credit or rural finance?

Agricultural development is necessary but not sufficient to achieve rural development. To achieve broad rural development objectives a paradigm shift is essential from agricultural credit to rural finance market development. Many reasons support this position.

Rural economy is heterogeneous 

The notion of the agricultural dependent rural economy is archaic. Within the heterogeneous rural economy there is a potentially vibrant rural non-farm enterprise (RNFE) sector which includes rural industries and service enterprises. A majority of rural households are pluriactive. This is supported by hard data. According to the 2016 Household Income and Expenditure Survey of the Census and Statistics Department, agricultural activities accounted only for 9.7% of the total monthly average household income of rural households while non-agricultural activities accounted for 16.7% and wages and salaries accounted for 37%. 

The RNFEs themselves are diverse and include manufacturing, agricultural processing and service enterprises such as agricultural machinery repair services, agro-processing industries, retail trade and rural tourist services. They are labour-intensive and dominated by micro and small enterprises. Most of the RNFEs use poor quality technology and are in general characterised by low productivity. 

However, they provide employment opportunities; they reduce rural-urban income differences. And they are an important source of income for women and landless workers. They not only reduce the vulnerability of rural poor to various economic shocks but also make a positive contribution to reduce non-income dimensions of rural poverty. RNFEs can also facilitate agricultural adjustment in the development process and reduce the costs that would entail such adjustments. 

Need credit for a range of purposes

In this structural context, rural households demand, not just agricultural credit but credit for a broad range of activities: they demand credit for investments in diverse RNFEs, children’s education, health expenses and emergencies, and for consumption purposes, for example. Lack of access to credit for RNFEs constraints their size, growth and the capacity to generate more productive employment. Credit constraints compel some to continue with the use of obsolete technology leading to low productivity and some others to forgo profitable investment opportunities. Inadequate access to credit for education and health purposes limit human resource development and exacerbate socio-economic inequalities in the rural economy.

Vast demand for deposit services

Beyond credit for a wide range of purposes, they need easy and effective access to deposit, payment and insurance services. Savings are critically important for low-income and poor people simply because they do not have much money. 

The Global Findex Data show that only 4.63 million Sri Lankan adults (15+ years), or about 29% of the adult population, saved their money in a financial institution in 2016. If we generously assume that 70% of these 4.63 million adults were in the rural sector that would be about 3.2 million or only about 45- 50% of the income receiving individuals in the rural sector. The Global Findex data also showed that about 2.0 million adults saved in informal sources in 2016. Even if we assume that only 50% of them were in the rural sector that is a large number in absolute terms.

These numbers suggest that financial institution outreach in rural areas for deposit mobilisation is disappointingly low. This is a serious flaw in the rural financial system and the current policy regime of the country.

Increased savings and the liquidity that savings provide to the households will increase their willingness and capacity for risk bearing. Over time the buildup of savings may reduce the need for credit. More importantly, greater savings over time will increase their capacity to face external shocks better and reduce the need to rely on government handouts. It is important to recognise that rural households have both the capacity and willingness to save, as has been demonstrated repeatedly in Sri Lanka and by virtually all other developing countries for decades.

Rural economy badly needs robust financial services

When considering the structural characteristics of the rural economy and its dynamic aspects from a development point of view, what it demands is sound and robust rural financial services, not just agricultural credit. Such services as deposit, credit, payment and insurance, help rural households to manage their risks, smoothen consumption, take advantage of profitable economic opportunities, build human capital, and income earning and other assets, and improve their standards of living.

In the sphere of credit supply, innovative loan products may be required. If the focus is confined to agricultural credit, the households will invariably resort to diversion of part of the loan proceeds to other activities, which is difficult for lenders to prevent. Hence, it is advisable to introduce policies and measures to meet the total demand for credit from rural households in an effective manner. 

Crop-specific agricultural credit is cumbersome

Current policies and approaches favour crop-specific agri-credit and pay relatively less emphasis on other components of the total household demand for credit. Crop-specific credit is a cumbersome and inadequate way to address the demand for credit in the rural economy. A farmer who cultivate, say three different crops, has to get three loans, for example. The transaction costs (the costs of establishing and conducting financial relationships) of such credit is high for both lenders and borrowers which in turn adversely affect the supply of credit and loan repayments by the borrowers. Transaction costs are admission tickets to financial markets. High price of the ticket keeps low income people away from the financial markets because the incidence of this cost is too high on small value transactions. 

In this regard, it may be advisable for the lenders to think of an innovative general loan product that provides sufficient degree of liquidity and freedom for the clients to use the loan proceeds in a more efficient manner.


We need a paradigm shift from agricultural credit to dynamic and robust rural financial system that can provide a range of products and services in competition with informal markets among others. Only with that kind of financial services can we build a healthy and strong rural economy that can support not only itself but also the rest of the economy on a sustainable basis while freeing the rural households from the grip of the rapacious money lenders.

In 2000, the Asian Development Bank (ADB) carried out a massive study on Rural Financial Markets in Asia. The undeniable conclusion of the study was that ‘Rural financial markets in Asia are ill-prepared for the twenty-first century’. Unfortunately, 20 years on that conclusion remains valid for Sri Lanka.

(The writer is a development economist with over 40 years’ experience in the field. He is former Associate of the Kuala Lumpur-based global organisation, Alliance for Financial Inclusion and former Practice Leader for Microfinance at the Asian Development Bank. He is the author of ADB published book (2008) titled ‘Rural Development Outcomes and Drivers’. He can be reached at