The impact of Informal Credit on Poverty and Inequality: The Case of Vietnam

The informal credit market remains an important source of finance for the poor in Vietnam. Yet, little if anything is known about the ultimate impact of informal loans on poverty and inequality. If informal credit is an important means to decrease poverty, the government may want to reconsider its policy focus. Although it is possible to stimulate the availability of informal credit, the Vietnamese government has no policies to do so and focuses solely on direct provision of microfinance. In this paper we therefore estimate the average effect of informal credit on expenditures of borrowing households, and subsequently assess its impact on poverty and inequality. By using fixed-effect regressions with instrumental variables, we intend to eliminate the potential bias caused by differences between participants and non-participants in credit markets. We find that the poor borrowed proportionally more from informal sources than the non-poor and that informal credit was quite effective in decreasing poverty: it reduced the poverty incidence of borrowers by 8 percentage points and the overall poverty incidence of population by 1.4 percentage points in 2006. Similarly, informal credit significantly decreased the poverty gap index and the poverty-severity index. The effects on expenditure inequality were small.