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Do Firms Want to Borrow More? Testing Credit Constraints Using a Directed Lending Program

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  • Banerjee, Abhijit
  • Duflo, Esther

Abstract

We begin the Paper by laying out a simple methodology that allows us to determine whether firms are credit constrained, based on how they react to changes in directed lending programs. The basic idea is that while both constrained and unconstrained firms may be willing to absorb all the directed credit that they can get (because it may be cheaper than other sources of credit), constrained firms will use it to expand production, while unconstrained firms will primarily use it as a substitute for other borrowing. We then apply this methodology to firms in India that became eligible for directed credit as a result of a policy change in 1998, and lost eligibility as a result of the reversal of this reform in 2000. Using firms that were already getting this kind of credit before 1998, and retained eligibility in 2000 to control for time trends, we show that there is no evidence that directed credit is being used as a substitute for other forms of credit. Instead the credit was used to finance more production – there was significant acceleration in the rate of growth of sales and profits for these firms. We conclude that many of the firms must have been severely credit constrained.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4681.

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Date of creation: Oct 2004
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Handle: RePEc:cpr:ceprdp:4681

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Keywords: banking; credit constraints; India;

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References

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  1. Steven N. Kaplan & Luigi Zingales, 2000. "Investment-Cash Flow Sensitivities are not Valid Measures of Financing Constraints," NBER Working Papers 7659, National Bureau of Economic Research, Inc.
  2. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-48, April.
  3. Abhijit V. Banerjee & Andrew F. Newman, 1990. "Occupational Choice and the Process of Development," Discussion Papers 911, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  4. Oded Galor & Joseph Zeira, 2013. "Income Distribution and Macroeconomics," Working Papers 2013-12, Brown University, Department of Economics.
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