Does weather risk explain low uptake of agricultural credit?: Evidence from Ethiopia

Credit markets are key instruments by which liquidity constrained smallholder farmers may finance productivity investments. However, the documented low demand and uptake of agricultural credit by smallholder farmers in sub-Saharan Africa poses challenges for energizing rural transformation in the region. In this paper we investigate the impact of rainfall uncertainty (and risk more generally) on the expressed demand for credit among rural households in Ethiopia. We explore potential mechanisms through which weather risk may explain the low demand for credit. We also examine the consequences of uninsured rainfall uncertainty on productivity-enhancing and loss-reducing agricultural investments. We provide evidence that rainfall uncertainty dampens households’ demand for agricultural credit. Rainfall uncertainty is associated with credit risk-rationing, which underlies the low demand for agricultural credit in Ethiopia. We also show that rainfall uncertainty helps to explain the low uptake of productivity-enhancing agricultural technologies, such as fertilizers. On the other hand, rainfall uncertainty encourages investments in defensive agricultural inputs, such as pesticides, herbicides, and fungicides. Our results highlight the impacts of uninsured production risk on agricultural investments made by African smallholders.