Formal and informal finance in the peasant economy: a case study in Arusha region, northern Tanzania.

Tanzania is one of the developing countries which have adopted a formal credit supply strategy to provide for the credit needs of the small peasant farmers. The strategy was supported by conventional arguments, viz, peasants are poor to save and they face exploitative interest rates in informal credit markets. Therefore the strategy was aimed at increasing low priced credit from public sources and schemes partly to rescue the peasants from tire exploitation of the informal lenders (particularly the moneylenders) and partly to alleviate poverty among them by promoting increased agricultural productivity with the support of cheap formal credit. This study demonstrates that the peasants remained rationed by formal credit throughout the post-colonial period. In this context the experience shows that this effort did not generate significant changes from the colonial approach of favouring the large-scale farmers. The study argues that this deviation from the ideals of the post-colonial strategy was a result of poor lending policies, a weak credit delivery system (CDS), and a general dependency of the whole strategy on external image. Overall, the formal credit schemes did not assist the ordinary peasants as anticipated. Formal credit institutions, largely providing short-term loans in kind (seasonal inputs), had limited impact on long-term investment in agriculture and was, by the same token, inadequate in responding to the wide variety of credit needs in the peasant economy against this background, this study sets out to establish how the peasants provided for their financial needs. This study addresses three key issues. First, is what explains the deviation of actual experience from tire adopted strategy of formal credit schemes targeted at peasants. This question is mainly addressed in chapters 3 and 4 which review the experience with the formal credit schemes for the peasants in the colonial and post-independence periods. Second, is how did the peasants who were starved of formal credit meet their financing needs. This is addressed by investigating the saving and borrowing activities in a sample of rural households and identifying the main sources and destinations of financial flows in rural areas. Third, is to assess the observed financing arrangements against the received wisdom and test out key hypotheses from it. The usefulness of this lies in broader policy guides from the study. The use of survey data, discussed in chapter 5 and 6 with particular reference to the relevant variables of analysis, features prominently in addressing the second and third issues. The survey data used in this study are based on a single survey of a random sample of 256 households in Arusha region, Northern Tanzania. The survey was carried out in the 1989-90 agricultural crop season. The selection of the region was influenced by three main factors. First, was its experience with formal agricultural credit; second, is time and financial constraints; and third, is easy accessibility of the region and its hinterlands. By the same considerations, the survey was carried out in only three of the Arusha region's districts. The districts covered are Babati, Arumeru and Mbulu. 'The survey was based on a structured questionnaire which was administered once to the household heads. The most important questions in the questionnaire focused on the type and size of household assets, incomes, expenditures as well as sources and uses of informal and formal finance. The primary data collected have been used in the descriptive and multivariate regression analysis presented in chapter 7. The main empirical findings on informal finance reveals that the sampled household had very little use of formal credit, and financial savings were scarce. In general, this finding attested to a limited use of Formal Financial Institutions (FFIs) for saving and borrowing purposes. Instead the analysis of the data revealed the existence of diverse Informal Financial Institutions (IFIs) used by the sampled households. The most important among the IFIs reported as sources of credit included friends, neighbours and family members. Savings were also held in informal institutions. These were mainly in the form of cash, physical assets and food cereals. Most prominent among the IFIs were Rotating Savings and Credit Association (ROSCAs), neighbours, Saving and Credit association (SCA) and a diverse number of other custodians. Moreover, the results show that the traditional informal lending institutions including moneylenders, landlords and crop buyers were found to be of limited importance or were non-existent. In particular, an insignificant level of lending by moneylenders was established in Babati and Arumeru districts only; and no crop-buyers were found to exist in any of the districts surveyed. This finding demonstrates that commercial lending was of limited importance in the areas surveyed. Instead therefore non-commercial lending practiced by friends, relatives and neighbors predominated. According to the survey results the credit extended was more in kind than cash. These included credit in the forms of food, physical assets such as livestock and in the form of labor services under Rotating Labor Associations (RLAs) which parallel ROSCAs. Since credit was mainly extended by non-commercial lenders, no explicit interest rate was charged. The survey evidence reveals that the average size of informal savings and loans is small and contrary to the conventional wisdom, both have not been for mainly smoothing consumption needs. Informal savings and loans were mostly reported to have been used for financing children education, purchase of farm inputs, crop harvesting, house building and for precautionary purposes in hard times. It is evident from the data that a larger proportion of savings and loans is used to finance productive activities in agriculture. According to the survey results the dominant use of informal financial sources was explained mainly by the absence of interest charges and timely availability of credit. Complexity of the FFIs did not emerge out as a relatively strong factor probably because of the limited use of formal credit markets. As regard informal savings, however, complexity of the FFIs, low interest rate offered by tte FFs remoteness from the FFIs and lack of information were the important factors reported. In both borrowing and saving a number of factors related to the attitudes of the peasants towards the FFIs also emerged. On the one hand, it emerged out that a significant proportion of the sampled household reported a habitual penchant for informal borrowing. On the other hand, some peasants exhibited the "poor to save" attitude and others considered the FFIs as creation of the Government for the rich petty-capitalist peasants. The latter may probably partly be a result of the restricted access to the formal agricultural credit sources. Results from the multivariate regression analysis complement the descriptive analysis by providing a sharper focus on the determinants of saving and borrowing as posited by theory. Both savings and borrowing are established to be respectively an increasing and decreasing functions of household expenditure and the size of land cultivated which were respectively used as proxies for income and wealth of the peasant households. Besides, both predictors were established to be significant in the estimated saving and borrowing functions. As would he expected for a peasant economy the marginal propensity to consume (MPC) is also established to be high but the marginal propensity to borrow (MPB) is apparently low if measured against the contention held that the peasants have a penchant for borrowing. The low MPB is considered to have been a product of credit scarcity attributable to what was reported as a decrease in trust amongst the peasants. On the basis of the "poor to save" hypothesis which forms one of the pillars of the formal agricultural credit scheme, the sample was stratified into poor and rich peasants using an arbitrary poverty line. The main result in this exercise demonstrates that income and wealth were the only important determinants of saving and borrowing amongst the rich peasants; and the rich had relatively larger MPB and MPS than the poor ordinary peasants. Further analysis incorporating demographic characteristics revealed that the age and dependency rates were not important determinants of either borrowing or savings in the sampled households. Even where the dependency rate was decomposed into young and aged dependents, only signs alternated but neither was a significant determinant of the regressands under consideration. An attempt was made to use the age profile of the households to test the life-cycle (LCH). The results confirmed those from the descriptive analysis which were inconclusive. The hump-pattern in savings across age profiles was not indicated. The only demographic factor found to significantly influence saving and borrowing is the education of the households heads interviewed. This predictor was established to positively influence savings and to be negatively correlated to borrowing. The same results were obtained from a yet an institutional factor arising from the operations of the FFIs, viz transaction costs. The results established this regressor to be positively related to saving and borrowing. However, it was only significantly different from zero in the saving function. It has become evident in this study that the IFS derives its advantages and strengths amongst the peasants from low transaction costs, absence of complexity in transactions, proximity to the peasants, and not least its existence as a traditional financial technology where trust rather than security and formality associated with the FFIs is its main base. From. this it could be argued that its existence and sustenance derives from trust coupled with informality, personal contact and information on clients and low administrative costs in contrast to the attributes of FFS. Generally results of the study have demonstrated the existence of a dual financial infrastructure in the peasant economy although the former is the most dominant. The potential for an increased role of FFS exists if identified weaknesses are addressed. The implications of this duality of the financial structure on the policy approach towards rural finance is that formal credit may still play an important role in the future to complement the 1FS and premature abandonment may prove to be counter-productive. To ensure that the credit needs of the peasants are met the study argues for a synchronization of the diverse proposals on financial institutions for the poor and government support in terms of training the manpower, establishing the facilities, etc., for their effective take-off. A useful intermediate approach may be to formalize/encourage informally constituted but legal Saving and Credit Societies (SCS); and other well recognized informal groups at the village level that are engaged in financing activities.