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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

For 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

Our 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

we thank Tina Abad, Lynette Aspillera, Almaz Beyene, and Ginette Mignot for their

administrative support. The guidance of Lawrence Haddad and Sudhir Wanmali in

providing an enabling research environment deserves special recognition. We thank

John Pender, the IFPRI internal reviewer, and two anonymous external reviewers for

their critical but very constructive comments, which helped us significantly improve

the analysis in and presentation of the report. Particular sections of this report have

also benefited from the comments of Alain de Janvry, Andrew Foster, Lawrence Had￾dad, Soren Hauge, Hanan Jacoby, Manohar Sharma, John Strauss, and participants

in the Bunda/IFPRI workshop on rural finance held in October 1996 at Bunda, in

seminars at IFPRI, and in various conferences at which papers emanating from this

research were presented during 1996–98. Last but not least, we gratefully acknowl￾edge the financial support of the Rockefeller Foundation; UNICEF Malawi; the Min￾istry of Women and Children’s Affairs and Community Services (MOWCACS); the

German Agency for Technical Cooperation (GTZ) in Malawi; and the United States

Agency for International Development (USAID) in Malawi.

ix

Summary

As in many countries in Sub-Saharan Africa, the majority of poor smallholders

in Malawi are left out of the agricultural extension and credit systems. These

households, characterized by landholdings of less than 1 hectare and very low crop

yields, are unable to grow enough food to feed themselves even though they focus

much effort on producing food crops, especially maize. It has been argued that most

of these farmers are too poor and cash-strapped to be able to benefit from any kind

of access to credit and that, even if they received adequate supplies of the right in￾puts, their land constraints are so severe that any increase in productivity would still

fall short of guaranteeing their food security. For these households, credit to support

nonfarm income-generating activities has been suggested as a policy alternative for

alleviating their food insecurity.

To gain a better understanding of the possible role of credit in improving house￾hold food security and alleviating poverty in Malawi, in November 1994 the Inter￾national Food Policy Research Institute and the Department of Rural Development,

Bunda College of Agriculture, University of Malawi, initiated a research program on

rural financial markets and household food security in Malawi. The main objective

of the research 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 finan￾cial services, it can inform policymakers about the social benefits (if any) of policy

strategies to promote the formation and expansion of microfinance institutions in ru￾ral areas. Second, the analysis can provide knowledge about the relative importance

of the various socioeconomic factors within or beyond the control of policy that de￾termine whether or not some households will benefit from access to formal credit.

This latter information can guide the design of institutional arrangements and the

choice of financial services to be offered to different target groups.

The research emanating from this program was published during 1996–98 in a

number of reports and papers disseminated by IFPRI and the Bunda College of Agri￾culture, following an October 1996 workshop held at the college at which the major

x

Summary

research results were shared and discussed with policymakers, microfinance practi￾tioners, and researchers. This research report presents an in-depth analysis address￾ing the research objectives described.

The study analyzed the determinants of access to formal and informal credit and

the demand for loans. It found that formal lenders in Malawi—such as rural banks,

savings and credit cooperatives, and special credit programs supported by the gov￾ernment and nongovernmental organizations—prefer to give loans to households

with diversified asset portfolios and therefore more diversified incomes. This is pre￾sumably done to increase and stabilize repayment rates. It also found that households

in Malawi are generally credit constrained in both the formal and informal sectors of

the credit market. For example, close to half of the households participating in for￾mal credit programs still have binding credit constraints. However, Malawian house￾holds 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 services play a larger role. These attributes

include the types of loans provided and the restrictions on their use, as well as the

types of nonfinancial services provided by the programs, such as training in the man￾agement of microenterprises. This result suggests that the acceptance of an institu￾tion by its clientele, and therefore its prospects for growth and sustainability, are de￾termined by a range of characteristics of both its financial and its nonfinancial

services.

The main findings of the study regarding the impact of access to credit on house￾hold welfare outcomes do not support the notion that improving access to micro￾credit is always a potent means for alleviating poverty—an opinion voiced, for ex￾ample, at the Microcredit Summit in Washington, D.C., in February 1997. Both the

tabular and the econometric analysis shows that when households choose to borrow

they realize lower net crop incomes than nonborrowers. Although this result is not

statistically significant, it nonetheless points out the risk of borrowing: that bor￾rowers can be worse off after repaying the principal and interest.

Two main reasons for the negative (albeit insignificant) relationship between bor￾rowing and net crop incomes are identified. Both have important implications for fi￾nancial sector policy and the conduct of rural financial institutions in Malawi. The

first reason is the focus of the loan portfolio on one loan product, which provides

farmers too much costly fertilizer for hybrid maize. Three of the four institutions in￾vestigated in this study provided agricultural credit, focusing mainly on an input

package for hybrid maize. The second reason is the below-average rainfall in the two

survey years and the concentration of the loan portfolios of the formal lenders on

maize, a drought-sensitive crop.

Consistent with the insignificant results for crop income, we find no significant

impact of access to credit on the per capita incomes, food security, and nutritional

status of credit program members. As the credit services of the formal institutions

are mostly 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 cov￾ered in this study do not offer financial products, such as consumption credit and pre￾cautionary savings options, that could eventually have a direct effect on consump￾tion or on nutritional status.

Growing tobacco is found to be the most important determinant of household

crop income. Another finding of the study, however, is the fact that households that

grow tobacco are less food secure, with significantly lower per capita daily calorie

intake and a higher prevalence of both chronic and acute malnutrition compared with

households that do not. The food insecurity and malnutrition of tobacco households

may be traced to the combination of larger than average household sizes because of

the labor-intensive nature of tobacco growing and the high relative cost of buying

maize for consumption.

The study also found that the price of maize has a significant and negative direct

impact on household per capita calorie intake, while its indirect effect on the latter

through household income is positive but statistically insignificant. This finding is

consistent with two other findings of the study: that the marginal impact of the price

of maize on household income, although sizable, is not statistically different from

zero and that smallholder farmers in Malawi are, on average, net buyers of maize be￾cause of their 59 percent average maize self-sufficiency. Therefore any increase in

the price of maize is likely to have a negative impact on the food security of the av￾erage smallholder farm household.

A major conclusion of this study is that the contribution of rural microfinance in￾stitutions to the income of smallholders can be limited or outright negative if the de￾sign of the institutions and their services does not take into account the constraints

on and demands of their clients. Developing attractive credit services requires both

identifying farm and nonfarm enterprises and technologies that are profitable under

the conditions experienced by subsistence-oriented farmers and responding to the

numerous constraints of resource-poor rural households. The results suggest that a

strategy of expanding financial institutions in rural, drought-prone areas with inad￾equate market and other infrastructure may—at least in below-average rainfall

years—have no significant positive welfare effects. The risk of drought in Malawi,

as in much of rainfed Sub-Saharan Africa and other countries, constitutes a consid￾erable challenge for developing sustainable rural financial institutions. In such envi￾ronments, a strategy providing for greater diversification of the portfolio of assets

and liabilities of the rural financial 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 realize its full potential benefits for

Malawi’s rural population. Therefore—considering that the formation of sustainable

rural financial institutions is a difficult task to achieve in rural economies that lack

xii

irrigation, exhibit insufficient hard and soft infrastructure, and support a poorly ed￾ucated rural population adversely affected by malnutrition and disease, and consid￾ering that the benefits at the household level may not materialize in drought years—

the report recommends a cautious and gradual strategy for expansion of rural

financial institutions in Malawi. This strategy would require direct support by the

state through an adequate legal and regulatory framework, through the support of in￾stitutional innovations and pilot programs in rural areas that may have the potential

to reduce transaction costs in providing savings, credit, and insurance services to ru￾ral clientele.

Adoption of a cautious strategy would also imply that the formation and initial

expansion of rural financial institutions should focus on high-potential agricultural

areas that allow for lending to those growing a diversified array of cash and food

crops as well as offering financial services for off-farm enterprises at low transaction

costs. This does not mean that low-potential and drought-prone agricultural areas

should be neglected, because credit may be the best or only option for the small￾holder farmers to finance their input acquisitions after experiencing a crop failure.

Indeed the evidence showed that without access to credit the ability of smallholder

farmers to recover from a crop failure is extremely limited. The mere knowledge that

credit will be available in case of crop failure can be beneficial to poor farmers by

inducing them to adopt new and more risky but potentially profitable crops or tech￾nologies. The econometric analysis has confirmed the positive and quite sizable

(though not statistically significant) impact of merely having the option to borrow,

even if it is not exercised. However, the expansion of microfinance into marginal ar￾eas with insufficient market and other infrastructure should be coupled with a greater

emphasis on other growth- and welfare-enhancing investments (such as those in

transport, health, and communications infrastructure) and with targeted safety-net

interventions for the very poor.

In summary, the benefits of access to credit for smallholder farmers depend on a

range of agroecological and socioeconomic factors, some of which are time-variant

and subject to shocks such as drought. Access to credit is therefore no panacea for

poverty alleviation. The full potential of credit access in increasing the welfare of the

poor can only be realized if coupled with adequate investments in hard and soft in￾frastructure as well as investments in human capital.

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