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Author:

• Sudipto DASGUPTA
  Hong Kong University of Science and Technology

In many countries, Development Financial Institutions (DFIs) have been major conduits for channeling funds to particular firms, industries and sectors during their process of development. In India, DFIs have been a more important source of long term funds (mainly debt) for industry than commercial banks or other sources of debt. Using data from the Indian corporate sector, we evaluate the role of DFIs in India for the period 1989-1997 by examining how firms’ investment decisions are affected by their ability to access DFIs. We find that firms that had prior access to DFIs continue to receive funds from these sources only if they can be classified as a priori more financially constrained. Access to DFIs for funds spurs investment. These results suggest that DFI lending is not governed by considerations of lobbying, precedence or even to sponsor particular types of projects that might be socially desirable but not privately profitable.  Rather, the primary role of DFIs has been to reduce financial constraints faced by firms. We also find that the drastic contraction of long term bank lending to industry in India in the early nineties had adverse consequences for firms that were particularly bank-dependent, but only if these firms could be classified as a priori more financially constrained.Together, these results support the view that in contrast to firms in well developed capital markets, in emerging markets, firms with growth potential are likely to rely significantly on debt financing, especially debt that is channeled through financial intermediaries.