What Does Debt Relief Do for Development? Evidence from India’s Bailout Program for Highly-Indebted Rural Households

This paper studies the impact of a large
debt relief program, intended to attenuate investment
constraints among highly-indebted households in rural India.
It isolates the causal effect of bankruptcy-like debt relief
settlements using a natural experiment arising from
India's Debt Relief Program for Small and Marginal
Farmers -- one of the largest debt relief initiatives in
history. The analysis shows that debt relief has a
persistent effect on the level of household debt, but does
not increase investment and productivity as predicted by
theories of debt overhang. Instead, the anticipation of
future credit constraints leads to a greater reliance on
informal financing, lower investment and a decline in
productivity among bailout recipients. The results suggest
that one-time settlements may be insufficient to incentivize
new investment, but can have significant real effects
through their impact on borrower expectations.