Credit Risk in Colonial India

by Maanik Nath (Utrecht University)

This blog is based on the author’s article which has been published in the Economic History Review and is now available as open access at: https://onlinelibrary.wiley.com/doi/full/10.1111/ehr.13108

The Indian economy performed puzzlingly under colonial rule.  Transport networks developed, markets expanded, and farmers shifted from payment-in-kind to transactions in cash.  These changes, however, did not result in the growth of the economy.  Output was volatile and starvation widespread.

A large share of the population relied on small-scale, low-yield farming to earn a living.  Land quality was generally poor, with little improvement during the colonial period. Private investment in wells and water tanks, and in cultivation, remained low.

Small and expensive credit markets constrained the peasant’s ability to improve land.  Commercial banks did not lend to farmers.   To overcome this problem, rural households with disposable income provided loans to other households in the same village. Using new data from the Madras Presidency, my research shows that risk affected credit supply in distinctive ways.

Why was lending risky?  Ecology mattered because some regions fared better than others.  Madras contained wet (irrigated) and dry (rainfed and semi-arid) districts (Figure 1.)

In an average year, land in the dry hinterland received between one-third and one-fifth the rainfall of land in the fertile deltas (Figure 2).  Land in the driest terrains yielded about half the crops per acre than land in the deltas.  The risk of crop failure was higher in the dry districts compared to the wet, which presented a greater set of challenges for credit markets in the former relative to the latter.  Because climate volatility was uninsurable, crop failures bankrupted borrowers and thereby  constrained the supply of credit in the following year.

Moneylenders responded strategically to climatic risk. Credit was scarce and borrowers were selectively chosen in high-risk regions. With their dependence on single crops from poor quality land, holders of small land parcels in dry areas could not easily access credit. Conversely, scale and crop diversification insured against risk which meant that large landholders were more likely to obtain credit. In the wet regions, because climatic risk was lower, borrowers were plenty and credit was available across income categories, including peasants.

Consequently, enforcement systems, differed according to the risk profile of the borrower. Contract enforcement in courts was not always a viable option to manage risk because borrowers did not wilfully default on loans in high-risk areas. In drought years, peasants commonly approached famine camps and relied on food welfare entitlements. In such cases, force majeure clauses in contract laws instructed court judges to protect borrowers. Citing protection from ‘acts of God’, judges voided contracts and revoked penalty charges when borrowers were unable to meet credit bills due to weather-induced crop failure.

Partly reflecting the inherent problems of fixing liability when defaults occurred as a result of ‘acts of God’, court actions were expensive, and the resolution of cases was protracted. To avoid high enforcement costs, creditors in dry districts rarely secured loans with contracts. Instead, repayments were obtained through informal, inflexible methods instead. The archives indicate that lenders often used unscrupulous ways of retrieving unpaid loans from smallholders, including seizing the welfare entitlements of peasants outside famine camps in bad years. In better years, poor borrowers parted with crops or, in some cases, jewellery and furniture.

Contracts were more commonly used in the low-risk areas. When the value of loans exceeded the costs of enforcement, lenders in wet districts approached the courts and established flexible repayment terms for first, and second-time defaulters.

In short, moneylenders rationed credit and imposed harsh enforcement restrictions in dry areas while lending more inclusively and adopting flexible recovery methods in irrigated regions. These results provide lessons for investment, suggesting that climatic risk and volatile seasonal incomes restricted private investment levels in the dry areas because savings rates were low and access to credit preferential.

From the mid-twentieth century, provincial and federal governments tried expanding the supply of cheap credit by fixing interest rates, outlawing private money lenders and introducing lending targets for nationalized banks. However, these policy strategies did not address the underlying problem of ecological risk, which persisted.

To contact the author: m.nath@uu.nl, @MaanikNath