Does direct foreign investment affect domestic firms credit constraints ? ∗

Firms in developing countries typically cite credit constraints as one of their primary obstacles to investment. By bringing in scarce capital, it is often argued that foreign direct investment may ease domestic firms’ credit constraints. Alternatively, if foreign firms borrow heavily from domestic banks, they may exacerbate domestic firms’ credit constraints by crowding them out of domestic capital markets. One plausible mechanism by which this may happen is indirect. Foreign firms may be more experienced and have better financial ratios and thus, be a safer bet for lending institutions. Using firm-level data from the Ivory Coast for the period 19741987 we test the following hypotheses: (1) domestic firms are more credit constrained than foreign firms and (2) borrowing by foreign firms exacerbates the credit constraints of domestic firms. Results suggest that foreign borrowers crowd out domestic borrowers. We also explore differences in financing constraints and crowding out between public and private enterprises. Our results suggest that public sector enterprises are less financially constrained than other domestic enterprises, consistent with the notion of a “soft budget constraint”. Finally, we explore possible explanations for the apparent crowding out effect. ∗ PRELIMINARY WORK IN PROGRESS PLEASE DO NOT CITE OR CIRCULATE. Thanks to Eleanor Park for excellent research assistance. Thanks to Pierluigi Balduzzi for several helpful comments, and to Ray Fisman and Dan Richards for comments on an earlier draft. ♣ Tufts University Department of Economics, 617 627 3137, email:[email protected] ♠ Columbia Business School, 212 854 2760, email:[email protected]