Impact of Interest Free Microcredit on Returns to Capital: Evidence from Randomized Experiment in Pakistan

Abstract 

Global microfinance movement is driven by a fundamental claim that once poor microentrepreneurs are given access to capital, they are able to generate high returns. The evidence on returns to capital is mixed and too limited to substantiate this claim. This paper reports on a field experiment from Pakistan in which we gave exogenous shock to the capital stock of randomly selected microenterprises. The treatment was given in the form of interest free loans. We find that treatment significantly increased the working capital of the treated microenterprises. In response to exogenous infusion of capital, monthly business profits also significantly increased. Using randomized treatment as an instrument for capital, we find average monthly returns to capital of 8.6% – 11.9%. These returns are sustainably higher than the interest rates charged by microfinance institutions in Pakistan

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Roy Huijsmans