Role of Targeted Credit in Rural Non-farm Growth

Author(s): Shahidur R. Khandker

Source: The Bangladesh Development Studies, Vol. 24, No. 3/4, RURAL NON-FARM
DEVELOPMENT IN BANGLADESH (Sept.-Dec. 1996), pp. 181-193
Published by: Bangladesh Institute of Development Studies
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The Bangladesh DevelopmentStudies

Vol. XXIV,Sept.-Dec. 1996. Nos. 3 & 4

Role of Targeted Credit in Rural

Non-farmGrowth
by
Shahidur R. Khandker*
In a labour surplus countrylike Bangladesh, rural non-farm(RNF) sector
is importantnot only for povertyalleviation but also for promotingoverall
economic growth.Lack of credit has proved to be a binding constraintto the
growthof RNF activities.MicrocreditfromGrameen Bank, BRAC, and RD-12
programme of the BRDB has played a significant role in relaxing this
constraintand promotingRNF activitiesin Bangladesh. Data fromhousehold
level survey show that both household characteristicsand communityfactors
are important determinants of RNF participaion. Better infrastructure
promotes RNF participation while better income earning opportunities in
agriculturereduce it. Trade and manufacturingare the dominantformsof RNF
activities in Bangladesh. Household attributes, village characteristics, and
prices and wages have been found to explain a significantpart of variations of
the choice structureof the RNF activities.Analysisof borrower-level
data clearly
indicates that because of skill trainingand other organizational help, BRAC
borrowers have managed to sustain increased productivitywith improved
access to credit.Therefore,the supply of affordablecreditforthe expansion of
RNF productionmust be supported by appropriate skill development,market
promotion,and other organizationalsupports.

I. BACKGROUND
Bangladesh's labour forcehas been growingat 2.4 per cent per
and modernsectorscan absorb an increaseof
year,but its agriculture
1.7
cent
per
only
per year. The surplus labour attemptsto find
in
the
employment
country'srural non-farm(RNF) sector which is
an
becoming
increasingly significant source of income and
for
the majority of the rural poor. This sector is
employment
not
important
only for povertyalleviation,but also for promoting
overalleconomicgrowth
.The extentto whichRNF activitiescan lead to
broad-based economic growth,however,depends criticallyon the
ofthe RNF activities,existenceof dynamicmarketniches,
profitability
and the strengthof the forwardand backwardlinkagesof the sector
withthe restofthe economy.
*The WorldBank.

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182

The BangladeshDevelopment
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While the programmesfor rural works, and other targeted

interventions
such as the vulnerablegroup developmentprogramme
(VGDP) help the poor gain access to income and employment
in natureand cannot sustain the
opportunities,
theyare short-term
means
of
the
Also
it has been foundthat lack of
productive
poor.
access to affordable
creditis a major obstacle to self-employment
of
the poor, particularlyin RNF sector. In this contexttargetedcredit
interventions
such as GrameenBank, BRAC,and RD-12 programme
BRDB
of the
play an importantrole in raising the income and
employmentof the rural poor. These programmesare found to
creditand otherorganizational
increaseRNF employment
by providing
and skill developmentinputs. Collateral-basedfinancialinstitutions
such as commercialbanks and agriculturaldevelopment
banks, and
lenders,also financethe RNF sector,but their
possiblyeven informal
as those ofmicrocredit
rolesare not as significant
programmes.
This paper discusses the following:(1) the major sources of
financeforRNF activitiesand theirrelativeimportance,
(2) the extent
of credit constraints faced and simultaneous borrowingby the
households involved in RNF activities, (3) the determinate of
in RNFsector,as wellas in particularRNFactivities,and
participation
(4) the rate ofreturnin RNFactivities,and sourcesofproductivity.
II. SOURCES OF FINANCE FOR RNF ACTIVITIES

In the absence ofaggregate-level

data, the relativeroles ofdifferent
institutionshave been examined at the household level using the
householdsurveydata collectedin 1991/92 from1,798 householdsin
87 villages.The householdswereselectedrandomlyon the basis of a
village census with more than the proportionalnumberforcertain
groups of households. However,the household survey data were
appropriatelyweightedin order to representthe actual population
ofthevillagessurveyed.
distribution
can be broadlyclassifiedintoformal,
The sources ofRNFfinancing
informal, and microfinance. Formal finance constitutes
collateral-basedinstitutionssuch as commercialand agricultural
banks, microfinanceincludes targetedcredit programmessuch as
Grameen Bank (GB), BRAC, RD-12, and other NGOs and
cooperatives, and informal finance includes friends, relatives,
moneylenders,acquaintances and so on. In programmeareas,
targetedcredit programmeshave done the most to promoteRNF
activities.Amongthose who participateand borrowfromany of these
RNF activitiesaccountfor62 per cent ofthe total
threeprogrammes,

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183

Khandker: Role ofTargetedCredit

amountborrowed.
Amongthosewho are eligiblebut do notparticipate,
RNF activitiesaccountedforonly27 per cent of total borrowing.On
the other hand, among those who are ineligibleto participatebut
borrowfromothersources, only 12 per cent of totalborrowingis for
RNF activities.As Table I shows,the RNF sectoraccounts for48 per
cent of the total loans advanced by formalfinancial institutions
comparedwith28 per cent of the informalloans and 60 per cent of
microfinance.The majorityof the loans fromthese three credit
programmes were taken for the purchase of nonagricultural
equipmentand capital. The averageloan size variedfromTaka 4,212
for Grameen Bank to Taka 2,276 for BRAC, and Taka 2,584 for
RD-12.
TABLE I
RNF LOAN SIZE AND ITS SHARE IN TOTAL LOAN BY SELECTED SOURCES
(Total numberof loans-2985)
Non-agricultural
equipment/capital
AverageLoan
Size (taka)

Sources
Formal credit
sources

Non-agricultural: Othersa

% ofTotal
AverrageLoan
Volume of Loan
Size (taka)

% ofTotal Volume
of Loan

9611.4
(17267.2)

8.2

64113.9
(61867.6)

39.9

RD-12

2583.8
(946.8)

34.1

3282.1
(1956.8)

22.8

BRAC

2275.9
(1057.7)

35.6

3009.3
(1708.0)

28.1

4211.6
(1364.0)

45.9

3911.8
(1587.3)

15.6

3800.2
(2676.0)

9.2

5015.7
(5075.1)

18.7

Microcredit
sources

Grameen
Bank
Informal
creditsources

Notes: Figures in parentheses representstandard deviations.

a
Others"includes purchase of rickshaw/boat/
"Non-agricultural:
fishingnets, and
purchase of land, house or otherequipmentfornon-farmenterprises.

GrameenBank, BRAC,and RD-12 account for80 per cent of the

creditadvanced by all microcreditprogrammes.Amongthese three
microcreditprogrammes,Grameen Bank has the largest network,
coveringmorethan halfof all villagesin Bangladesh.The RNF sector
receivesthe lion's share (65-100 per cent) ofthe annual lendingof all
threeprogrammes
(see Figure1).

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184

The BangladeshDevelopment
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Figure 1
RELATIVE DISTRIBUTION OF ANNUALDISBURSEMENT BY CREDIT
PROGRAMMES IN FARM AND RNF SECTORS, 1994

. DETERMINANTS OF HOUSEHOLD
PARTICIPATION IN RNF ACTIVITIES

About48 per cent of the 1,798 householdscoveredin the survey

participated in the RNF sector at any time over the crop year
1991/92. However,only27 per cent of all householdsparticipatedin
basis. As Table II shows,bothhousehold
RNF activitieson a full-time
and communityfactorsas well as marketwages and prices played
regardingany typeof
importantroles in householddecision-making
RNF participation.For instance,RNF participationis higheramong
male-headed households than among female-headedhouseholds.
Landholding,which providesalternativeemploymentopportunities,
in the RNFsector.
reducesthe likelihoodofa household'sparticipation
for
and
sugar,all ofwhichlead
egg,potatoes
Similarly,higherprices
to higher farm income, encourage households to concentrateon
activities.By contrast,femaleand child
farmingratherthan off-farm
Rural
labourwages rates have a positiveimpacton RNF participation.
but irrigationreduces it,
increases RNF participation,
electrification
perhapsprovidingalternative
wage and incomeearningopportunities.
RNF participation is higher in Grameen Bank villages than
non-programme
villages, although it does not vary among RD-12,
BRAC and non-programme
villages. In sum, better infrastructure
RNF
while
betterincome-earning
opportunities
promotes
participation,
in agriculture
reduceit.

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Khandker: Role ofTargetedCredit

185

TABLEII
OP THE PARTICIPATION
INRNPACTIVITIES
DETERMINANTS
(Probitestimate)
Variables
Explanatory

Coefficients
BothPartand Full-time
Participants

Sex ofhouseholdhead (l=male;O=female)

(decimal)
Logofhouseholdlandholding
Villagepriceofhenegg(taka)
Villagepriceofpotato(taka)
Villagepriceofbrownsugar(taka)
Villagefemalewagerate(taka/day)
Villagechildwagerate(taka/day)
landarea in village
ofirrigated
Percentage
has
Village electricity?
Villagehas BRAC?
Villagehas RD-12?
Villagehas GB?
Constant
Loglikelihood
Numberofobservations

0.518
-0.045
-0.137*
-0.177
-0.046
0.020
0.038
-0.394**
0.434
-0.107
0. 104
0.221
0.239
-1157.33
1,798

variablesare shownhere.
and programme
Notes : Onlythesignificant
placement
Variablesare significant
at 10%level
Variablesare significant
at 5% level

The RNF activitiesare aggregatedintofivemajorcategoriesby the

similarityof the productionprocess involved.The distributionof
households involved in these avtivitiesis shown by programme
status in Table III. Amongthe 1,108 householdsinvolved
participation
in any of these fivemajor RNF activities,19 per cent are involvedin
47 per centIn trade,about 7
16 per centin transport,
manufacturing,
in
11
cent
livestock
and
and
fisheries,
per
per cent in otheractivities.
So trade and commerceis the predominantformof RNF activitiesin
Bangladesh. Next to trade, manufacturingis the second largest
activityamong all programmeparticipants and non-participants,
who wereinvolvedmorein transport.
exceptforBRACparticipants

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Studies
The BangladeshDevelopment

186

TABLE III
DISTRIBUTION OF HOUSEHOLDS BY RNF ACTIVITIES FOR
DIFFERENT PROGRAMME PARTICIPATION STATUS

ProgrammeParticipationStatus

Activity

Manufacturing(%)
Transport (%)
Trading (%)
Livestockand
fisheries(%)
Others (mostly
services) (%)
Numberof
observations

NonNonAU
participants target households

RD-12

GB

13.8
21.4
47.8
4.4

20.5
14.2
42.5
14.2

23.1

17.2

17.7

19.3

16.8
45.1
7.0

20.9
44.6
7.1

4.4
63.7
3.5

16.4
47.1
6.6

12.6

8.7

8.0

10.1

10.6

10.5

159

254

286

296

113

1.108

BRAC

in RNF activities,
what determines
the
Now,giventhe participation
choice structureof RNF activitiesin Bangladesh?A multinomiallogit
(MNL) was run (not shown here) to determinethe choice of a
relativeto serviceactivitiesdue to a changein one of
particularactivity
the explanatoryvariables.GrameenBank promotestransport,trade,
activities.On the other
and livestockcomparedto service-oriented
activities
overmanufacturing,
service-oriented
hand, BRAC promotes
commercialbanks also promote
transport,and trade. Interestingly,
tradeand livestockrelativeto services.Betterroads reducetradeand
livestockactivitiesrelativeto services.Village-levelprices and wages
rolein a household'sselectionofRNF activities.
also playan important
Wages for a particular type of labour (male, female and child)
representan alternativeof RNF activity(hence,a substitutioneffect
For example,an increasein the male wage rate
and an incomeeffect).
increases transportand livestockcompared to services, while an
increasein the femalewage reducestransportbut increaseslivestock
but
activity.By contrast,the child wage increases manufacturing,
A villagethathas no activewagemarketfor
reduceslivestockactivities.
femalelabour(and henceno observedfemalewage)promotestradeand
activities.Trade and livestockprovide
livestockover service-oriented
more self-employment
for women than other activities, perhaps
because they are compatible with women's role in household
commoditiesalso affect
non-market
production.The pricesofdifferent
the choice structureof RNF activities.Of particularinterestare the
pricesof rice,the majorfoodcrop in Bangladesh,flourand beef.The

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Khandker: Role ofTargetedCredit

187

rice price promotesthe transportsector over the servicesector. By

contrast, the flour price reduces transportactivities relative to
services. The beef price increases livestock production as well
manufacturing,transport,and trade over other activities. Both
human and physical capital influencethe choice structureof RNF
activities. Thus, education of household head and household
landholding status promote service-oriented activities over
transport,and livestock.Overall,MNLmodelexplains
manufacturing,
22
ofthe variationsofthe choice structureofthe RNF
cent
about
per
in
terms of these household attributes, village
activities
and pricesand wages.
characteristics,
IV SOURCES OF PRODUCTIVITYIN THE RNFSECTOR
The RNF sectoris an important
source ofincomeand employment
forruralhouseholds,especiallyforthe poorwho do not have enough
land to supportthemselves.Figure2 showsthe relativedistribution
of
income and employmentof individuals. It is worth noting that
(65 per cent)
agriculturalsector,despiteprovidingmore employment
than the RNF sector,has a returnof only45 per cent.This suggests
that RNF activities are more rewarding than traditional farm
activities.
Figure2
RELATIVE DISTRIBUTION OF INDIVIDUAL
EMPLOYMENT AND INCOME

Giventhe significance
ofthe RNF sectoras a source ofincomeand
will
it
be
to examinethe relativecontribution
employment,
interesting

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188

The BangladeshDevelopment
Studies

of the three targeted credit programmes,and other factors to

in the RNF sector.The Cobb-Douglasproductionfunction
productivity
is used (not shown here) to identify
framework
the relativeroles of
various factors.Sixtyper cent of the productivity
differences
among
households
and
55
cent
per
target
amongnon-targethouseholdsare
explainedby the model forall RNF activities.Estimates show that
Grameen Bank placement has increased RNF production in
manufacturing for target households, trading for non-target
households, and RNF sector as a whole forthe targethouseholds.
BRACplacementhas increasedproductionin manufacturing
fortarget
in
for
and
but
it has
households,
trading
non-targethouseholds,
in
RNF
sectoras a wholeforbothtargetand
increasedproduction the
non-targethouseholds. Similarly,RD-12 placement has increased
manufacturingfor target,tradingfor non-target,and overall RNF
productionfortargethouseholds. Thus programmeplacements,in
of participants,
create
additionto influencing
directlythe productivity
induced demandor supplyeffectwhichbenefitnon-participating
and
non-targethouseholds too. However, there are inter-programme
in a particularRNF activity.For
variationsin raising productivity
is
the growthof productivity
example,in the Case of manufacturing,
the largestforthe BRAC (22 per cent) followedby the RD-12 (12 per
cent) and the Grameen Bank ((11 per cent). But for all activities
combined,the impacton targethouseholdsis highestforthe BRAC
(10 per cent), followedby the GrameenBank (8 per cent) and the
RD-12 (4 per cent).Non-target
households,however,benefitonlyfrom
the BRAC (10 per cent).
Traditionalbanks apparentlybenefittargethouseholdsmorethan
non-targethouseholds. If the villagehas a bank, RNF productionis
increasedby 3 per centfortargethouseholds.Seasonalityis especially
pronouncedin the servicesectorand it is higherin the Aus season
than in the Aman. The household head's education has a positive
trade,and overallRNF productionforboth
impacton manufacturing,
The privatereturnon one year of
households.
and
non-target
target
education in the RNF sectoris slightlyhigherfornon-target(5 per
cent) than for targethouseholds (3 per cent). Labour has positive
ofmanufacturing,
transport,trading,and
impactson the productivity
RNF
as
a
whole
fortargethouseholds.
sector
and
on
otheractivities,
at
37 taka per manday
labour
is
calculated
of
The marginalproduct
and
51
taka
households
for target
per manday for nontarget
is close to the average
for
household
The
households.
figure target
rate
of
40
taka
for
wage labour.
nonagricultural
dailywage

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Khandker: Role ofTargetedCredit

189

V. RATE OF RETURN, CAPITAL INTENSITY

AND LABOUR PRODUCTIVITY

The growthpotentialof RNF activitiesis measured by rate of

return(ROR) whichis definedby the ratio of the difference
between
revenue and the cost of all types of inputs (includingcapital and
costs) over the amount of
familylabour inputs at theiropportunity
fixedand workingcapital (in taka). Capital intensityis measuredby
the capital-labourratio(CLR)wherecapitalis thevalue offixedcapital
and labour is the male equivalentmanday. Capital productivity
is
measured by capital-outputratio (COR) which is the value of fixed
capitaloverthe totalvalue ofproduction(in taka). On the otherhand,
labour productivity
is measured by the output-labourratio (OLR)
whichis the value of outputoverthe totalnumberofmandays.Table
IV presents these ratios by type of activityand by programme
participationstatus. The ROR is highestin livestockand fisheries,
followedby manufacturing,
trading,services and transport.Capital
intensityis highestfortradingactivities,whereaslabour productivity
is highestin livestock.Amongthe programmeparticipants,ROR is
highest for RD-12 participants,whereas capital intensityas also
is highestfornon-target
labourproductivity
households.
TABLE IV
RATE OP RETURN (ROR), CAPITAL-LABOUR RATIO (CLR), CAPITAL-OUTPUT
RATIO (COR) AND OUTPUT-LABOUR RATIO (OLR) OF RNF ACTIVITIES BY
ACTIVITY AND PROGRAMME PARTICIPATION STATUS
ROR(%)

Activity

Manufacturing
Transport
Trading
Livestock
and fisheries
Others(mostlyservices)
Total

CLR

COR

OLR

3.591
1.187
3.096
10.180
2.539

93.415
18.641
200.28
47.198
114.597

0.393
0.438
0.415
0.124
0.570

604.078
65.209
817.476
1247.711
484.155

3.214

129.068

0.413

633.111

ProgrammeParticipation
Statue
BRAC

2.59

86.92

0.34

432.75

RD-12

4.43

46.93

0.34

428.21

GB

2.84

103.53

0.34

506.40

Non-participants

3.05

73.17

0.42

435.72

Non-target

4.03

362.46

0.48

1334.53

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190

The Bangladesh DevelopmentStudies

Data analysis shows that semi-urban areas have higherreturns in

manufacturingactivitiesthan that in rural areas. Also BRAC's role is
worth noting for manufacturing, a key activity in rural led
industrialization. As mentioned in the previous section productivity
growthis highest in BRAC villages. In addition, BRAC borrowersnot
only have low capital intensity,but also the highest returns of labour
formanufacturing.Given BRAC's intensive skill promotiontraining,it
is likelythat its members attain higherreturnson manufacturing.
VL SUSTAINABBLITYOF THE BORROWERS
Programme participation helps increase employment for those
who are unemployed or underemployedand provides self-employment
opportunities for those who are wage-employed. An estimate of the
incidence of poverty shows that incidence of both moderate and
extreme poverty are higher among non-participants than among
programme participants in programme villages. Programme
participants also have more savings, assets, and networth than
non-participantsin all programmevillages (Khandker and Chowdhury
1995).
the causal impacts of borrowing
Econometric estimates identifying
fromtargeted credit programmes show that borrowing,especially by
women, substantially increases per capita expenditure and hence
reduces poverty(Pitt and Khandker 1996). For example, for Grameen
Bank borrowersthe rate of return of borrowingon expenditure is 19
per cent for female borrowingand 12 per cent for male borrowing.
When these rates of return,at currentlevels of borrowingand lengths
of programme participation, are combined with the level of
consumption required to alleviate poverty(5,250 taka per capita per
year), it is found that it takes about 9 years for the average female
Grameen borrowerto lift her familyout of povertyfromthe date of
her joining the programme.
Although borrowers of the credit programmes pay a higher
interestrate than the borrowersof commercialor developmentbanks,
Table IV suggests that they are able to pay this high interestrate and
still earn profitfrominvestmentin RNF activitiesbecause of theirhigh
rate of return (2.8 for GB participants, 2.6 for BRAC participants,
and 4.4 forRD-12 participants).

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Khandker: Role ofTargetedCredit

191

Vu. EXTENT OF CREDIT CONSTRAINTAND

SIMULTANEOUS BORROWING

Average returns to capital are much higher for non-target

households than for programme participants and target
As Table IV shows,the capital-labourratiois highest
non-participants.
households.Thus, due to morecapital per unit
(362.5) fornon-target
in RNF activitiesis highest(1,335 Taka
labour
of labour,
productivity
for
per manday)
non-targethouseholds,followedby GrameenBank
participants(506 taka), targetnon-participants(436 taka), BRAC
participants (433* taka) and RD-12 (428 taka). This raises the
question whetherprogrammeparticipantslack access to funds for
and rate
increasingcapital so as to increasebothlabour productivity
ofreturnon capital.
of
Fromthe aggregateproductionfunctions,
marginalproductivity
capital is calculated for both target and non-targethouseholds
involvedin the RNF sector.The marginalproductofcapitalwas found
to be 0.48 for target households and only 0.05 for non-target
to increasethe
households.Since the returnson capital are sufficient
size of an enterprise'scapital,the existenceof a capital constraintin
productionimpliesthe existenceofa creditconstraintfromthe supply
side. This means that participantsof targetedcredit programmes
such as the GrameenBank, BRAC, and RD-12 cannot borrowas
muchas theywouldliketo.
the extentof the
Also householdsurverydata is used to identify
credit (supply) constraint.Households were asked if they would
borrowat the prevailinginterestrate if therewere no constraintson
the supplyside. All activitiesweresubjectto creditconstraint,
ranging
from54 per cent in transportto 74 per cent in livestock.Similar
creditconstraintswerefoundforborrowersofthe creditprogrammes
(67 per cent forBRAC borrowers,73 per cent of RD-12 borrowers,
and 63 per centofGB borrowers).
Because of these creditconstraints,it is possible that theydraw
on varioussources to financetheirenterprises.In fact,morethan 40
per cent of BRAC members,43 per cent of RD-12 members,and 51
per cent of GrameenBank membersuse more than one source to
financestart-upcapital. Use ofmultiplesources of start-upcapital is
highestin livestockand fisheries(39 per cent)and lowestin transport
and otheractivities(27 per cent).

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VIII. SUMMARY AND CONCLUSIONS

In a labour-surpluscountrysuch as Bangladesh, expansion in

rural non-farm production and employmentis necessary for
promotingbroad-based economic growth.This is because RNF
activitiesrelyon and promotelabour-intensive
production,
generating
fora largenumberof people.Also, as mentionedbefore,
employment
RNF sector accounts forabout 55 per cent of rural incomewhile it
provides35 per centofthe ruralemployment.
Lack of access to credit is a binding constraint on RNF
participation.The data shows that households with more than 50
decimalsof land, and householdswithless than 50 decimalsof land
that are not part of any targetedcreditprogramme,
use mostlytheir
ownsavingsto startup an RNFactivity.
The fixedand workingcapital
of RNF activitiesrendersself-financing
formany
difficult
requirement
ruralhouseholdsand hence,programmes
such as the GrameenBank,
the BRAC and the BRDB's RD-12 that provide credit and
organizationalhelp are likely to promoteRNF production.Data
analysis confirmsthat these programmeshave increased overall
RNFparticipation.
village-level
An expandedmarketwithbetterinfrastructures
can help promote
RNFgrowth.Data analysisshowsthatthe returnsare higherin small
towns than in rural areas for the important RNF activity,
Despitethe factthatruraltownshave betteraccess to
manufacturing.
competingnon-ruralnon-farmgoods, the returnson manufacturing
are higher in semi-urbanareas than that in rural areas. Better
marketsand infrastructure
are perhapsgood facilitators
forRNF-led
growth.
Improvingaccess to affordablecreditand raisingthe amount of
creditavailableare waysto improvebothparticipation
and productivity
in the RNF sector. However,only bettercreditavailabilitymay not
ensure the dynamismin the RNF sectorthat is requiredto increase
data forthe three
growthand employment.
Analysisof borrower-level
credit
indicates
that
because of skill
targeted
programmesclearly
and
other
BRAC
borrowers
have
training
organizational help,
to
sustain
increased
with
access
to
managed
improved
productivity
credit.Therefore,
the supplyof affordable
creditforthe expansionof
RNF productionmust be supportedby appropriateskill development,
marketpromotio,
and otherorganizational
policymeasures..

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Khandker: Role ofTargetedCredit

193

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All use subject to JSTOR Terms and Conditions