Interest Controls and Credit Allocation in Developing Countries

Abstract

PLANNING AUTHORITIES in less developed countries (LDCs) often regard financial market intervention as an efficient way to induce gr()wth and structural change. Elaborate regimes of interest ceilings and subsidies have been used to promote industrialization, exporting, geographic decentralization, and other national priorities. Some of these programs have doubtless achieved their intended objectives. However, with inflation frequently exceeding controlled interest rates, they have also tended to generate an excess demand for loans. Legally prohibited from price discrimination, creditors have been obliged to allocate their portfolios according to various criteria, and loan applicants whom creditors find relatively unappealing have been forced to rely heavily on self-finance or the unregulated curb markets. McKinnon (1973) and Shaw (1973) have argued that such rationing regimes lead to serious factor misallocations, inappropriate technology choices, and unnecessarily low growth rates. In the past decade their perspective has been formalized with macro models of financially repressed economies, and numerous supportive empirical studies have been reported (Fry (1982) surveys the literature). Surprisingly, however, several fundamental micro issues have received little attention: what is the nature of the bias in credit allocation that nonprice rationing induces; and how does