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

This research report and the underlying field research and data processing would not have been feasible without the essential and invaluable contribution of the re- search staff of the Bunda College of Agriculture, University of Malawi, and without the contribution of many others in Malawi, at IFPRI, and at other institutions. Fore- most, we are grateful for the assistance of the staff of the Department of Rural De- velopment (DRD) who contributed to the successful implementation of the field sur- vey, data cleaning, and data analysis for the DRD/IFPRI Rural Finance Study. We thank Karid Chirwa, Tyme Fatch, Swalley Lamba, Samson Manda, and Franklin Simtowe, who provided invaluable. | Do Firms Want to Borrow More Testing Credit Constraints Using a Directed Lending Program Abhijit Bannerjee Esther Duflo BREAD Working Paper No. 005 Revised August 2004 Copyright 2004 Abhijit Banerjee Esther Duflo B R E A D Working Paper Bureau for Research in Economic Analysis of Development Do Firms Want to Borrow More Testing Credit Constraints Using a Directed Lending Program Abhijit Banerjee Esther Duflo BREAD Working Paper No. 005 Revised August 2004 JEL Code O16 G2 Keywords banking credit constraints India 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. Abhijit Bannerjee MIT Department of Economics Cambridge MA 02142 bannerjee@ Esther Duflo MIT Department of Economics Cambridge MA 02142 eduflo@ We thank T ata Consulting Services for their help in understanding the Indian banking industry Sankarnaranayan for his work .

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