Financial Inclusion and Household Welfare

by Preetha Joseph

Financial inclusion is a key factor in the well-being of households. Access to formal financial services can ensure greater savings and consumption smoothing as well as improved production and employment opportunities. While there are dozens of policies aimed at enhancing financial inclusion in India, literature on the effectiveness of these is scarce. A new study by Manisha Chakraborty from IIM Calcutta and Subhankar Mukherjee from IIT Kanpur investigates the impact of the Pradhan Mantri Jan Dhan Yojana (PMJDY) scheme on the economic welfare of Indian households.

PMJDY is a nationwide program intended to ensure access to affordable banking and other financial services for all citizens. The programme aimed to open one bank account for every unbanked household when it was first introduced in 2014. Later in 2018, this was changed to opening one account for each unbanked adult. The program allows beneficiaries to open zero-balance accounts, and provides additional benefits such as life insurance coverage, debit cards, and provision of Direct Benefit Transfers (DBT) through the bank accounts provided under the scheme. According to official data, 47.09 crore beneficiaries have opened bank accounts under the scheme, as of October 2022.

In this paper, researchers draw a link between financial inclusion and household welfare. A common measure of economic welfare of households is consumption expenditure and more specifically, diversification of consumption expenditure. Poorer households tend to allocate a large share of expenditure on food and other essential goods. Wealthier households are able to allocate more expenditure on non-essential and luxury goods.

The researchers use CPHS panel data to study three main hypotheses. The first is that financial inclusion programs result in a decrease in the share of food expenditure along with increased diversity within food expenditure. The second hypothesis is that an increase in income, enabled by greater access to financial services, leads to increased diversification in non-food expenditure. Thirdly, they investigate whether increased access to financial resources leads to a shift of households from food consumption to non-food consumption.

The paper employs two-stage regression and the Theil Diversification Index to study these hypotheses. The Theil Diversification Index is an entropy-based index developed by Henry Theil. Essentially, it measures the ‘dividedness’ or ‘diversification’ within and between entities in a system. In this case, the authors apply the index to understand diversification between food and non-food expenditure as well as diversification within food expenditure of Indian households. They analyse data across 9 Waves of CPHS data, and compare their results for the period before and after the implementation of PMJDY.

The researchers observe that increase in formal financial inclusion does lead to diversification of household consumption. This diversification is seen within non-food items as well as between food and non-food items. They find similar diversification patterns for rural and urban households. Additionally, their results indicate that diversification is positively associated with income and wealth. However, this effect varies across social and religious groups. The also find that socially vulnerable groups are less likely to shift between food and non-food consumption basket.

The study provides a new path in studying the association between financial inclusion and household welfare. The authors will present their work in the upcoming CPHS Research Seminar, on October 27th, 2022. Their work will be discussed by Arpit Gupta from New York University.

The webinar is open to the public. Please register for the event here.

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