ABSTRACT
There is by now a vast literature, both theoretical and empirical, on the effects of interest rate deregulation on the growth of developing countries. Equally vast is the literature on the effects of foreign aid, the implications of the existence of informal credit markets and the implications of financing budget deficits by alternative sources. However, in virtually no work on the effects of interest rate deregulation are all these different strands brought together. Of course, there are efforts which try to combine one or more of these issues. For example, Van Wijnbergen (1983), and others in the 'structuralists' school, examine the role of informal credit markets, but they pay very little attention to the role of foreign aid, wealth effects, crowding out of private credit by the needs of the government to finance budget deficits, and so on. Morisset (1993) examines the effect of crowding out of private credit caused by the government's budgetary needs and a shift in the private sector's portfolio caused by interest rate deregulation. But he treats budget deficits as being exogenous, ignores the role of foreign aid and informal credit markets and treats savings as being exogenously determined, thus eliminating all indirect effects of deregulation via changes in wealth. Gupta (1993) rectifies some of the shortcomings of Morisset (1993), but still ignores foreign aid and informal credit markets and takes budget deficits as given. Gupta and Lensink (1993) enlarge the model by incorporating informal credit markets. But they leave out foreign aid and treat government deficit as being exogenously given. In a subsequent paper, Gupta and Lensink (1994) bring together the government sector and foreign aid. They explicitly endogenise the budget deficit and examine the effects of interest rate deregulation in the presence of aid under the assumptions of it being exogenous and endogenous. However, in this case, they ignore the informal credit markets. Their analysis is again partial given that the deregulation effects are sensitive to the existence of such markets.
