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N° 2007-11 |
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| May 2007 |
| FDI and Credit Constraints: Firm Level Evidence in China |
Jérôme Héricourt
Sandra Poncet |
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The Chinese banking sector has traditionally been considered by authorities as a substitute
for state financing to ensure a continued flow of funding to its state-owned enterprises to
preserve jobs. This structure inherited from the socialist planned economy deprived emerging
private enterprises from access to external funding. During the mid-nineties, Chinese
authorities took step to reform the financial system through recapitalization and transfer of
non-performing loans (NPL) to asset management companies. These reforms have been
made necessary by China’s WTO commitments of ending restrictions in the banking sector.
The ability of the Chinese financial system to allocate capital more efficiently and to guarantee
non distortionary financial access to all companies, including private firms is therefore
a key indicator to assess the success of the ongoing reform.
A great deal of research demonstrates the importance of well-developed financial markets
for economic growth. In China, despite the fact that the country has a very large and deep
pool of financial capital, relatively few firms have access to formal finance. A survey by
the Enterprise Analysis unit from the World Bank on 94 countries conduced in 2000 highlight
that 80% of private firms in China cite financing constraints as major obstacle. This
figure - twice the median figure of the sample (38.5%) - ranks China as the most financially
constrained country. Such distortions may force private Chinese firms to look for foreign
investors (Huang, 2003). By establishing cross-border relationships with foreign firms, private
domestic firms can bypass both the financial and legal obstacles that they face at home.
It is therefore possible that, in the Chinese case, FDI provides capital to firms which would
otherwise be constrained in their growth by the inability to obtain funds, due to distortions
in the banking sector.
We rely on firm-level data to understand how exactly the fast-growing private Chinese firms
finance themselves and to verify whether private firms, which are generally discriminated
against by the local financial system, have been able to use foreign joint-ventures as a way
to acquire capital necessary for investment. This paper builds on two lines of research: 1)
studies of firm financing constraints and their determinants; and 2) studies on distortions
in China’s financial system. Our work follows the seminal work by Modigliani and Miller
(1958) suggesting that in perfect capital and credit markets, the investment behavior of a firm
is irrelevant to its financing decisions and vice-versa. However, in the presence of market
imperfections, any financing constraints will reflect on firms’ investment decisions. Empirically,
financing constraints could be identified through the sensitivity of investment with
respect to internal funds. In this paper, we estimate a structural model based on the Euler
equation for investment to investigate the extent to which firms are financially constrained
and whether incoming foreign investment in China plays an important role in alleviating
existing credit constraints. Using firm-level data on Chinese domestic companies for the
period 1999-2002, we test the following hypotheses: (1) domestic firms face different credit
constraints depending on their size and private or state-owned status (2) direct foreign investment
affects the credit constraints of domestic firms.
Our results suggest a striking difference between the credit constraints faced by domestic
private and state-owned firms. We find that our two firm-level measures of financial distress
(debt-to-asset ratio and interest coverage) do significantly affect investment for domestic
private firms, indicating that they are credit constrained. Investment of state-owned firms
on the opposite does not seem to significantly respond to these indicators. Nor is there any
evidence that it is significantly affected by FDI inflows.
The results however suggest that FDI inflows are associated with a reduction in financing
constraints for private domestic firms. FDI inflows appear to reduce the imperfections that
private domestic firms face when dealing with financial markets. These results are large and
robust to alternative model specifications.
This finding seems to confirm the general argument that the development of cross-border
relationships with foreign firms helps private domestic firms to bypass both the financial and
legal obstacles that they face at home. |
Non-technical summary |
Résumé non-technique
en français  |
Full text
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| Financial constraint; corporate finance; Foreign Direct Investment; China |
Keywords |
| E22; E44; G31; O16 |
JEL classification |
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