Financing Constraints: Determinants and Implications for Firm Growth in Pakistan

Abstract

This study has a twofold objective: (i) to investigate the determinants of firm growth, specifically the extent to which finance constrains enterprise growth; and (ii) to explore the determinants of external financial access in Pakistan. External financial access is defined as access to credit through institutional sources such as private commercial banks, nonbank financial institutions, and state-owned banks and agencies. The study uses data from the second round of the Investment Climate Assessment Survey conducted by the World Bank in FY 2007. The methodology entails using an instrumental variable approach to estimate the impact of external financial access on firm growth while employing a probit model to explore the determinants of external financial access. The results suggest the following: First, finance is a binding constraint to firm growth in Pakistan—a 10 percent increase in the working capital financed through external sources is predicted to increase the average annual growth rate by 5.6 percentage points. Second, financial depth is important for access—across the country, access is better where there is greater penetration of financial infrastructure. Third, a range of internal factors such as size, export status, quality of human capital, and organizational form emerge as important determinants of external financial access in Pakistan.