Monetary transmission in India’s informal finance sector..

This is the kind of research we should be doing more often in India kind of places. Much of research on mon transmission focuses on formal financial sector whose reach is limited. We still do not know how mon pol effects informal financial sector.

Saibal Ghosh and Rakesh Kumar of RBI look at the issue and have interesting findings:

This article utilises state-level data for 1961-2012 to examine the interlinkage between informal finance and monetary policy. The analysis suggests that in response to a monetary contraction, borrowing from moneylenders declines, whereas that from landlords and relatives increases. In addition, the evidence also supports a hierarchy among the preferred financing choices. A key takeaway is that monetary policy needs to take on board its impact on the hitherto neglected informal sector.

It is interesting to note how the transmission works here:

  • First, a rise in policy rates leads to decline in borrowing from informal sources. This is interesting as most would imagine that rise in policy rates makes formal finance expensive and people flocking to informal finance. But this is not the case as lending declines in informal sector too.
  • Decline is much lesser in moneylenders category compared to relatives, landlords etc. So first line of defence is moneylenders as people might not like to borrow from relatives due to shame etc.
  • However, there is a threshold and if rates rise, people do move to relatives etc. Cost of borrowing is negligible borrowing from such sources.

Interesting findings. The paper is really brief and misses the details. We need to have more and more research on this ignored aspect of mon transmission in India..

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