Essays on the Impact of Credit Policies in Developing Countries

Abstract

My doctoral research focuses on analyzing how credit policies and regulations affect the credit access of constrained firms. The first chapter focuses on the effectiveness of a national-level directed credit program in India. I exploit a policy-induced variation in program eligibility to study the differential impact of the program across the firm-size distribution. In the second chapter, I evaluate the impact of an export program that subsidized short-term export loans for manufacturing firms in India. I estimate the effect of the credit subsidy scheme on subsidized firms by mapping the eligible product lines to firms while controlling for firm- and sector-level differences across firms and accounting for shocks to export demand. Chapter 1. Governments around the world implement programs to improve the credit access of small businesses. Evaluating the impact of policies undertaken is important to ensure that the policies achieve the desired outcomes. However, in the absence of randomized policy assignment and the availability of controls for the credit demand of firms, establishing a causal link between the program eligibility and the improvement in credit access is an econometric challenge. In the first chapter “Could Directed Lending Programs Hurt Small Businesses? Evidence from India,” I study the impact of an expansion in a size-based directed or preferential credit policy that targets small businesses in India. In 2006, the Indian Government expanded the official definition of small businesses, thereby including relatively bigger firms in the pool of firms eligible for its large-scale directed credit program called the priority sector lending program. The discontinuity in eligibility to the nation-wide credit program helps identify the impact of the program across the firm-size distribution. Larger eligible firms are likely to be favored by banks because making bigger loans to larger firms helps banks economize on transaction costs while still meeting their directed lending quotas. Exploiting the eligibility discontinuity and using a modified difference-in-differences strategy, I find that the benefits of the policy intervention flow disproportionately to the larger firms. Newly-eligible firms experience an increase in the rate of growth of institutional credit, as well as higher investment and sales growth. The smaller, previously-eligible firms, on the other hand, are crowded out in the bank credit market, when compared to a reference group of ineligible firms. The positive impact on newly-eligible firms is highly correlated with firm size, even within the group. The financial constraints literature documents the role of banking relationships in overcoming credit constraints for small firms, specifically, the duration of the relationship and the multiplicity of bankers. Using the information on bankers of the firms and the duration of each firm-bank pair, I find that the firms with longer and multiple banking relationships experience less crowding out. While my analysis confirms the results from the empirical literature on the positive role of longer bank relationships and the multiplicity of bankers, I do not find evidence supporting the relationship-lending advantage of small and local banks. These findings suggest that the comparative advantage of small banks in relationship-lending is limited by the cost-minimizing incentive of banks. Moreover, firms that borrow from banks that are farther away from the mandated directed lending target experience less crowding out as well. Smaller firms located in districts with more intense local competition from newly-eligible firms are also crowded out more, implying that such policy expansions could potentially worsen the existing regional disparities in access to institutional credit across the country. This study points to an important side effect of a well-intentioned policy intervention, aimed at increasing credit access of all small firms, and simultaneously providing banks with more lending avenues to achieve their directed lending targets. By virtue of its design, however, it distorts the lending incentives of banks, allowing them to exploit the policy shift as an opportunity to lower transaction costs. This suggests that in a setting with lending quotas if institutional lenders are unable to satisfactorily lower transaction and information costs, they will make loans to the largest eligible borrowers, whenever possible. Future policy design must be guided by research that assesses the overall impact of existing programs, in order to develop programs that expand access to finance while limiting economic distortions. Chapter 2. In “The Impact of Credit Subsidies on Export Performance,” I study the impact of an export credit intervention on the export performance of firms in the subsidized product lines in India, both at the intensive and at the extensive margin of exports. The Government of India formulated the Interest Rate Subvention Scheme in 2007 to reduce the cost of short-term credit for exporters in employment-intensive sectors, given their important contribution to the GDP and the workforce employment. Short-term loans of exporters are mainly working capital loans in the form of pre- and post-shipment export credit. Between 2007 and 2013, the government announced subsidies on short-term bank loans on a semi-annual or annual basis for specific sectors or product lines. The immediate goal of the scheme was to minimize short-term credit frictions of SMEs across all sectors, and large firms in export-oriented labor-intensive sectors. The long-term goal of the scheme, as has been understood in recent years when the subsidies were expanded, was to provide Indian exporters credit at internationally competitive rates. I construct a detailed data set which matches the balance-sheet data on medium and large exporting firms in the Indian manufacturing sector from 2006-2013, with their eligibility status based on products manufactured by them. To control for export demand shocks, I create a demand index that measures the product-level shocks to export demand, aggregated across importer countries for the firms in the sample. There are three key findings in this paper. First, I find that the impact of subsidies is estimated at about 5-8% in a difference-in-differences sense, compared to non-subsidized firms. The subsidies are not effective in the event of a substantial drop in world demand, as that experienced in 2009, in the aftermath of the global financial recession. This points to the limited usefulness of credit support as a policy tool during a major downturn. Second, the impact of credit subsidies is increasing in pre-existing fiscal benefits enjoyed by exporting firms, implying that there is a complementary effect of existing export incentives. The impact of the subsidy is also highly heterogeneous across firm-specific characteristics. Larger and more productive firms benefit to a lesser extent than their counterparts. In contrast to the findings in the literature, firms’ financial health indicators such as liquidity and leverage do not have any differential effect on the subsidized firms. Also, subsidized firms with longer bank relationships benefit relatively more. Finally, I do not find any impact on the export participation of firms, which is not unexpected given the short-term and unanticipated nature of the subsidy s cheme. The findings from these two studies are policy relevant not only for India but for other developing economies that implement similar policies. If government authorities and regulators in India want to effectively evaluate similar credit subsidy programs, they must be forward-looking and collect appropriate data that facilitate the evaluation of these programs, especially for small and micro-firms. Future research evaluating credit support programs would benefit immensely from improved data on variables such as employment, expansion in product variety and export destinations, as well as loan-level details of firms.