A model of credit constraint for MSMEs in India

Abstract

This study examines credit constraints using standard models in the highly constrained micro, small, and medium enterprises (MSMEs) sector in India. The mixed results may not be reflective of MSMEs in India, as the standard models have been developed for much larger firms in western markets having lower information asymmetry than Indian firms. These models are biased toward long-term financing due to the ready availability of short-term credit in western markets, as against limited access to working capital to MSMEs in India. We propose an augmented model of investment sensitivity based on the framework of the Fazzari and Petersen model and Carpenter and Petersen model that includes the often-neglected role of working capital as both a use and a source of funds, and gross fixed asset formation and leverage as drivers of credit constraints, for the information asymmetric MSME firms. The paper finds the augmented model, also called the Financing Deficit Model, robust for ascertaining credit constraints of Indian MSME firms and its variables consistent with available literature.

This is a preview of subscription content, access via your institution.

Notes

  1. 1.

    The classification of MSMEs is by gross block of plant and machinery in million Indian rupees (INR), by the Government of India, the ministry for MSME, as per the Micro, Small and Medium Enterprises Development (MSME) Act, 2006.

References

  1. Acevedo, G. L., & Tan, H. W. (2010). Impact evaluation of SME programs in Latin America and Caribbean. Washington, D.C. Retrieved from www.worldbank.org.mx

  2. Acharya, V., Almeida, H., & Campello, M. (2007). Is cash negative debt? A hedging perspective on corporate financial policies. Journal of Financial Intermediation, 16(4), 515–554.

    Google Scholar 

  3. Ahiadorme, J. W., Gyeke-Dako, A., & Abor, J. Y. (2018). Debt holdings and investment cash flow sensitivity of listed firms. International Journal of Emerging Markets, 13, 943–958.

    Google Scholar 

  4. Akoten, J. E., Sawada, Y., & Otsuka, K. (2006). The determinants of credit access and its impacts on micro and small enterprises: The case of garment producers in Kenya. Economic Development and Cultural Change, 54(4), 927–944.

    Google Scholar 

  5. Almeida, H., Campello, M., & Weisbach, M. S. (2004). The cash flow sensitivity of cash. Journal of Finance, 59(4), 1777–1804.

    Google Scholar 

  6. Athey, M. J., & Laumas, P. S. (1994). Internal funds and corporate investment in India. Journal of Development Economics, 45(2), 287–303.

    Google Scholar 

  7. Bagchi, A. K., Das, P. K., & Moitra, B. (2002). Are listed Indian firms finance constrained? Evidence for 1991–92 to 1997–98. Economic and Political Weekly, 37(8), 727–736.

    Google Scholar 

  8. Balfoussia, H., & Gibson, H. (2018). Firm investment and financial conditions in the Euro area: Evidence from firm-level data. Bank of Greece.

  9. Banerjee, A., & Duflo, E. (2001). The nature of credit constraints. Evidence from an Indian Bank. Retrieved from.

  10. Banerjee, A. V., & Duflo, E. (2004). Do firms want to borrow more? Testing credit constraints using a directed lending program. 51.

  11. Becchetti, L., & Trovato, G. (2002). The determinants of growth for small and medium sized firms. The role of the availability of external finance. Small Business Economics, 19(4), 291–306. https://doi.org/10.1023/a:1019678429111.

    Article  Google Scholar 

  12. Beck, T., & Demirgüç-Kunt, A. (2004). SMEs, growth, and poverty, do pro-SME policies work? The World Bank Group Private Sector Development, February 2004, 4.

  13. Beck, T., Demirgüc-Kunt, A., Laeven, L., & Maximovic, V. (2006). The determinants of financing obstacles. Journal of International Money and Finance, 25, 932–952.

    Google Scholar 

  14. Bhaduri, S. N. (2008). Investment and capital market imperfections: Some evidence from a developing economy, India. Review of Pacific Basin Financial Markets and Policies, 11(3), 411–428.

    Google Scholar 

  15. Bhalli, M., Hashmi, S. M., & Majeed, A. (2017). Impact of credit constraints on firms growth: A case study of manufacturing sector of Pakistan. Journal of Quantitative Methods, 1(1).

  16. Bhaumik, S., Das, P. K., & Kumbhakar, S. C. (2012). Firm investment & credit constraints in India 1997–2006: A stochastic frontier approach. Journal of Banking & Finance, 36(5), 1311–1319.

    Google Scholar 

  17. Bigsten, A., Collier, P., Dercon, S., Fafchamps, M., Gauthier, B., Gunning, J. W., Zeufack, A. (2003). Credit constraints in manufacturing enterprises in Africa.

  18. Bloom, N., Bond, S., & Van Reenen, J. (2007). Uncertainty and investment dynamics. Review of Economic Studies, 74, 391–415.

    Google Scholar 

  19. Bodla, B. S. (2004). SSI sector in India: Role, relative efficiency and road block. The Asian Economic Review, 46(1), 173–185.

    Google Scholar 

  20. Bond, S. R., & Meghir, C. (1994). Dynamic investment models and the firm’s financial policy. Review of Economic Studies, 61(207), 197–222.

    Google Scholar 

  21. Bottero, M., Lenzu, S., & Mezzanottiú, F. (2015). Sovereign debt exposure and the bank lending channel: Impact on credit supply and the real economy. Banca Italia Temi di Discussione, 1032.

  22. Campello, M., Graham, J. R., & Harvey, C. R. (2010). The real effects of financial constraints: Evidence from a financial crisis. Journal of Financial Economics, 97, 470–487.

    Google Scholar 

  23. Carpenter, R., Fazzari, S., & Petersen, B. C. (1994). Inventory investment, internal finance fluctuations, and the business cycle. Paper presented at the Brookings Papers on Economic Activity.

  24. Carpenter, R. E., & Petersen, B. C. (2002). Is the growth of small firms constrained by internal finance? Review of Economics and Statistics, 84(2), 298–309.

    Google Scholar 

  25. Chan, R. (2010). Financial constraints, Working Capital and the Dynamic Behavior of the Firm.

  26. CII. (2018). Easing Financing Challenges of MSME Sector: Short Term Recommendations. Retrieved from https://www.ciiblog.in/easing-financing-challenges-of-msme-sector-short-term-recommendations/

  27. Cleary, S. (1999). The relationship between firm investment and financial status. Journal of Finance, 54(2), 673–692.

    Google Scholar 

  28. Crisostomo, V. L., Iturriaga, F. J., & Gonzalez, E. V. (2014). Financial constraints for investment in Brazil. International Journal of Managerial Finance, 10, 73–92.

    Google Scholar 

  29. D’Espallier, B., Vandemaele, S., & Peeters, L. (2008). Investment-cash flow sensitivities or cash-cash flow sensitivities? An evaluative framework for measures of financial constraints. Journal of Business Finance and Accounting, 35, 943–968.

    Google Scholar 

  30. Deloof, M. (2003). Does working capital management affect profitability of Belgian firms? Journal of Business, Finance and Accounting, 30, 573–587.

    Google Scholar 

  31. Dewashis, K., & Chandra, R. (2010). National Conference on SMEs: Finance with Governance. Retrieved from http://www.tradeindia.com/newsletters/special_report/assocham_national_conference_2010.html

  32. Fazzari, S., & Petersen, B. (1993). Working capital and fixed investment: New evidence on financing constraints.

    Google Scholar 

  33. Fazzari, S., Hubbard, R., & Petersen, B. (1988). Financing constraints and corporate investment. Brookings Papers on Economic Activity, 1988(1), 141–206.

  34. Freimer, M., & Gordon, M. J. (1965). Why bankers ration credit. Quarterly Journal of Economics, 397–416.

  35. Ganesh-Kumar, A., Sen, K., & Vaidya, R. (2001). Outward orientation, investment and finance constraints: A study of Indian firms. Journal of Development Studies, 37(4), 133–149.

    Google Scholar 

  36. Gautam, V. (2011). Evidence on the dynamics of investment-cashflow sensitivity. Mumbai: Munich Personal RePEc Archive Indira Gandhi Institute of Development Research Retrieved from http://mpra.ub.uni-muenchen.de/35431/.

    Google Scholar 

  37. Gertler, M. (1988). Financial structure and aggregate economic activity: an overview. Journal of Money, Credit, and Banking, 20(3), 559–596.

  38. Greenwald, B., Stiglitz, J., & Weiss, A. (1984). Informational imperfections in the capital market and macroeconomic fluctuations. Information and Macroeconomics, 74(2), 194–199.

    Google Scholar 

  39. Guariglia, A., Liu, X., & Song, L. (2008). Internal finance and growth: Microeconometric evidence on Chinese firms.

    Google Scholar 

  40. Hashi, I., & Toci, V. Z. (2010). Financing constraints, credit rationing and financing obstacles: Evidence from firm level data in south eastern Europe. Economic and Business Review, 12(1), 29–60.

    Google Scholar 

  41. Holmes, S., & Kent, P. (1991). An empirical analysis of the financial structure of small and large Australian manufacturing enterprises. Journal of Small Business Finance, 1(2), 141–154.

    Google Scholar 

  42. Hoque, M., Sultana, N., & Thalil, T. (2016). Credit rationing’s determinants of small and medium enterprises (SMEs) in Chittagong, Bangladesh. Journal of Global Entrepreneurship Research, 6(1), 23.

    Google Scholar 

  43. Hutchinson, J., & Xavier, A. (2006). Comparing the impact of credit constraints on the growth of SMEs in a transition country with an established market economy. Small Business Economics, 27, 169–179.

    Google Scholar 

  44. Hyytinen, A., & Väänänen, L. (2006). Where do financial constraints originate from? An empirical analysis of adverse selection and moral hazard in capital markets. Small Business Economics, 27(4), 323–348.

    Google Scholar 

  45. Jaffee, D., & Russell, T. (1976). Imperfect information, uncertainty, and credit rationing. Quarterly Journal of Economics, 90(4), 651–666.

    Google Scholar 

  46. Jensen, C. (1986). Agency cost of free cash flow, corporate finance, and take-overs. American Economic Review (76), 323-329.

  47. Kaplan, S., & Zingales, L. (1997). Do investment cash-flow sensitivities provide useful measures of financing constraints? Quarterly Journal of Economics, 112, 169–215.

    Google Scholar 

  48. KPMG. (2018). The new wave of Indian MSME. Retrieved from https://assets.kpmg/content/dam/kpmg/pdf/2016/03/The-new-wave-Indian-MSME.pdf

  49. Krasniqi, B. A. (2007). Barriers to entrepreneurship and SME growth in transition: The case of Kosova. Journal of Developmental Entrepreneurship, 12(1), 71–94.

    Google Scholar 

  50. Kulkarni, P. R. (2008). A new deal for small and medium enterprises in India. The Icfai Journal of Entrepreneurship Development, V(1), 23–34.

    Google Scholar 

  51. Leland, H., & Pyne, D. (1977). Information asymmetries, financial structure and financial intermediation. The Journal of Finance, XXXII(2), 371–387.

    Google Scholar 

  52. Lensink, R., Molen, R. v. d., & Gangopadhyay, S. (2003). Business groups, financing constraints and investment: The case of India. Journal of Development Studies, 40(2), 93–119.

    Google Scholar 

  53. Milde, H., & Riley, J. (1988). Signalling in credit markets. The Quarterly Journal of Economics, 103(1), 101–129.

    Google Scholar 

  54. Ministry, M. (2009). Micro small and medium enterprises in India—an overview. Retrieved from

  55. Mishra, P. K. (2006). Performance of small scale manufacturing units in the post-economic reform with special reference to factor productivity: A study of five industrial clusters in Orissa. The Asian Economic Review, 48(2), 329–349.

    Google Scholar 

  56. Myers, S. (1977). Determinants of corporate borrowing. Journal of Financial Economics (5), 147-175.

  57. Myers, S. C., & Majluf, N. S. (1984). Corporate financing and investment decisions when firms have information that investors do not have. Journal of Financial Economics, 13(2), 187–221.

  58. Oliveira, B., & Fortunato, A. (2006). Firm growth and liquidity constraints: A dynamic analysis. Small Business Economics, 27(2), 139–156.

  59. Park, J. H., Park, K., & Ratti, R. A. (2018). Controlling shareholders and financial constraints around the world. Managerial Finance, 44, 92–108.

    Google Scholar 

  60. Petersen, M., & Rajan, R. G. (1994). The benefits of lending relationships: Evidence from small business data. , 49(1), 3–37. Journal of Finance, 49(1), 3–37.

    Google Scholar 

  61. Quader, S. M. (2016). Differential effect of liquidity constraints on firm growth. Review of Financial Economics, 32(1), 20–29.

    Google Scholar 

  62. Raheman, A., & Nasr, M. (2007). Working capital management and profitability—case of Pakistani firms. International Review of Business Research Papers, 3(1), 279–300.

    Google Scholar 

  63. Rajan, R., & Zingales, L. (1998). Financial dependence and growth. American Economic Review, 88, 559–586.

    Google Scholar 

  64. Riaz, Y., Shahab, Y., Bibi, R., & Zeb, S. (2016). Investment-cash flow sensitivity and financial constraints: Evidence from Pakistan. South Asian Journal of Global Business Research, 5, 403–423.

    Google Scholar 

  65. Richards, V., & Laughlin, E. (1980). A cash conversion cycle approach to liquidity analysis. Financial Management, 9(1), 32–38.

    Google Scholar 

  66. Samiloglu, F., & Demirgunes, K. (2008). The effect of working capital management on firm profitability: Evidence from Turkey. The International Journal of Applied Economics and Finance, 2(1), 44–50.

    Google Scholar 

  67. Schiantarelli, F. (1995). Financial constraints and investment: A critical review of methodological issues and international evidence. Boston: Boston College Economics Department—Working Papers in Economics.

    Google Scholar 

  68. Sen, S., & Ghosh, S. K. (2005). Basel norms, Indian banking sector and impact on credit to SMEs and the poor. Economic and Political Weekly, 40(12), 1167–1180.

    Google Scholar 

  69. Sharma, A. K., & Kumar, S. (2011). Effect of working capital management on firm profitability: Empirical evidence from India. Global Business Review, 12(1), 159–173.

    Google Scholar 

  70. Sharma, S. (2014). Benefits of a registration policy for microenterprise performance in India. Small Bus Economics, 42(153).

  71. Smith, K. (Ed.) (1980). Profitability versus liquidity tradeoffs in working capital management. St. Paul: West Publishing Company.

  72. Stiebale, J., & Wobner, N. (2017). M&A, investment and financing constraints. Dusseldorf Institute of Competing Economics, 257(July 2017), 1–60.

    Google Scholar 

  73. Stiglitz, J., & Weiss, A. (1981). Credit rationing in markets with imperfect information. Americam Economic Review, 71, 393–410.

    Google Scholar 

  74. Stiglitz, J. E., & Weiss, A. (1987). Credit rationing: Reply. American Economic Review, 77(march 1987), 228–231.

    Google Scholar 

  75. Stulz, R. (1990). Managerial discretion and optimal financing policies. Journal of Financial Economics(26), 3-27.

  76. Tori, D., & Onaran, Ö. (2017). The effects of financialisation and financial development on investment: Evidence from firm-level data in Europe. Greenwich Political Economy Research Centre (GPERC), 44, 65.

    Google Scholar 

  77. Uppal, V. (2006). Small scale industry in India: An analysis in the context of liberalization. SSRN eLibrary.

  78. Vishnani, S., & Shah, B. K. (2007). Impact of working capital management policies on corporate performance—An empirical study. Global Business Review, 8(2), 267–281.

    Google Scholar 

  79. Whited, T. M. (1992). Debt, liquidity constraints, and corporate investment: Evidence from panel data. Journal of Finance, 47, 1425–1460.

    Google Scholar 

  80. Williamson, S. (1986). Financial intermediation, business failures and real business cycles. The Journal of Political Economy, 95(6), 1196–1216.

    Google Scholar 

Download references

Author information

Affiliations

Authors

Corresponding author

Correspondence to Malcolm Athaide.

Additional information

Publisher’s note

Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

Appendix

Appendix

Table 9 Descriptive statistics of derived variables of models of credit constraints
Table 10 Correlation Matrix of Fazzari- Hubbard- Petersen Model
Table 11 Correlation Matrix of Carpenter-Petersen Model
Table 12 Correlation Matrix of Guariglia Model
Table 13 Correlation Matrix of Bond and Meghir Model
Table 14 Correlation Matrix of Financing Deficit Model

Rights and permissions

Reprints and Permissions

About this article

Verify currency and authenticity via CrossMark

Cite this article

Athaide, M., Pradhan, H.K. A model of credit constraint for MSMEs in India. Small Bus Econ 55, 1159–1177 (2020). https://doi.org/10.1007/s11187-019-00167-4

Download citation

Keywords

  • Micro, small, and medium enterprises
  • Credit constraints
  • Working capital
  • Panel data
  • Financing deficit
  • Information asymmetry