The COVID-19 Shock and Firm Financing: Government or Market? Or Both?

We study the interaction between government’s unconventional policies and firms’ market financing when access to foreign lending is sharply curtailed in an emerging economy, as observed at the onset of COVID-19. Using unique microdata of the universe of Chilean firms, we test the role of Central Bank’s special credit line to domestic banks and government-backed credit guarantees. Through a regression discontinuity design, we find that firms treated by the policies switched foreign debt for domestic debt due to a significant reduction in the relative cost of domestic credit. An open economy model with heterogeneous firms and endogenous financing helps rationalize these facts. In an environment where a COVID-19-type shock increases the cost of external financing, the joint implementation of the two policies yields a higher mass of firms with access to domestic credit and an equilibrium with both lower domestic rates and higher levels of domestic credit. The government’s credit guarantees loosen domestic collateral constraints and lower domestic banks’ risk aversion, while the central bank’s special credit line increases the aggregate supply of credit in the economy.