Imperfect Substitutes: The Local Political Economy of Informal Finance and Microfinance in Rural China and India

This article discusses reasons for the persistence of informal finance in China and India.Banking authorities in China and India have attempted to limit most forms of informal finance by regulating them, banning them and allowing certain types of MFIs. Thereby, they aim to increase the availability of credit to low-income entrepreneurs and eliminate their reliance on usurious financing. The intended clients of microfinance, however, continue to draw on informal finance. The article states that the persistence of informal finance may be traced to:

• Limited supply of formal credit;
• Limits in state capacity to implement policies;
• Political and economic segmentation of local markets;
• Institutional weaknesses of microfinance programs.

The article suggests that informal finance is not simply a result of weaknesses in the formal financial system, but also a product of local political, institutional, and market interactions. It presents case studies from India and China to illustrate how the combination of credit supply, local political economic conditions, and institutional characteristics of financial intermediaries mediates the dynamics of rural finance.