FDI and Credit Constraints: Firm Level Evidence in China

Abstract

In this paper, we analyze whether incoming foreign investment in China plays an important role in alleviating domestic firms' credit constraints. Access to external finance is a crucial determinant of business expansion. Using firm-level data on 2,200 domestic companies for the period 1999-2002, we investigate the extent to which firms are financially constrained and whether direct foreign investment relaxes financing constraints of firms. When we split domestic firms into public and private firms, we find that public firms' investment decisions are not sensitive to debt ratios or the cost of debt. Nor is there any evidence that public firms are affected by foreign firms presence. We interpret this as evidence in support of the notion of a soft budget constraint for public firms. In contrast, private domestic firms appear more credit constrained than state-owned or foreign firms but their financing constraints tend to ease in a context of abundant foreign investment.