Droughts and borrowing patterns in poor countries: Evidence from Tanzania

This paper examines whether and to what extent droughts reshape household borrowing patterns in fragmented credit markets in developing economies. Using nationally representative household panel data from the two most recent waves (2014/15 and 2020/21) in Tanzania combined with drought indicators, we analyse borrowing responses across lender types – banks, microfinance institutions, and informal lenders – and across credit purposes – business, non-food consumption, and subsistence expenditures. Tanzania is used as a representative case of sub-Saharan African economies that share three institutional features: fragmented credit markets with a dominant informal lending sector, rain-fed agricultural livelihoods exposed to drought risk, and low financial inclusion. The paper reports three findings. First, droughts do not increase borrowing from banks and microfinance institutions but significantly increase borrowing from informal lenders. Second, drought-induced credit is directed at subsistence rather than productive recovery. Third, we examine three mechanisms that may explain these patterns: financial inclusion, credit tightening, and drought-caused crop failures. Results show that households farther from bank branches and mobile money agents significantly increase informal borrowing during droughts. For credit tightening, we find no significant borrowing response from formal lenders, and in some cases, a decline in formal borrowing. Results also show that households experiencing drought-induced crop failures significantly increase subsistence borrowing. These results reconceptualise climate-shock credit response in fragmented financial markets, demonstrating that droughts can reallocate borrowing across market segments and loan purposes.