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.