Chapter 4


Box 4.3: Informal Credit Markets
In analysing the effects of monetary policies, an important issue to be considered are the linkages
which exist between the formal and informal credit markets. In many developing countries, informal
money-lenders are a major source of credit supply, specifically for poor urban households and in
rural areas. Although interest rates and other credit conditions are highly differentiated on informal
credit markets, interest rates are generally significantly above the rates on formal credit market. This
is for various reasons:

* higher administration costs due to the small size, unsecured nature and short duration of loans,
* higher risks of default,
* monopoly position of money-lenders.

To what extent will the informal credit market be affected by monetary and credit policies and the
changes induced on the formal credit market? Will the interest rates rise, too, to the same extent, or
will the differences between formal and informal credit market conditions narrow? There is no
definitive answer to this question. Increased interest rates on the formal market may attract savings
and monetary capital invested in informal markets, decreasing money supply and pushing up interest
rates there. On the other hand, a liberalised formal credit market may open the doors to those who
were dependent on the informal market before. In spite of increased interest in the formal credit
market they may still remain well below the informal market rates. This will reduce credit demand
in the informal market, with depressing effects on the interest rates there.

Although there are linkages between the formal and informal credit markets, it can be generally
assumed that the influence of monetary and credit policies on the latter will be much less. This
means that producers and household depending on informal sources of credit supply will remain
largely unaffected by restrictive monetary and credit policies under adjustment.




5.3 Impact on the food economy and food security

Fig. 4.7 presents the main lines of impact of monetary and credit policies from the macro-
through the meso- down to the micro-level of the food economy.

As said above, the most direct and significant effect of restrictive monetary and credit
policies is an increase in the real interest rate in the formal credit market. This means
increased costs for the producers as well as the other agents involved in food processing and
marketing who depend on the formal credit market as a source of finance for their
investments. The effects of increased production and marketing costs on the food economy
are described in Annex 1: food production (and, in consequence, market supplies) will
decrease and/or the food prices will rise (cost-push inflation), with the consequence. of
widening production, supply and demand deficits (for terminology see Annex 1). The
tendencies towards increased food deficits may, of course, be offset or reinforced by the
effects of other adjustment measures, depending on the specific conditions.


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