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Financial constraints and export market participation in the Arab Republic of Egypt

Youssouf Kiendrebeogo's picture

Geographical location, important seaports, and airports are factors facilitating international trade in the Arab Republic of Egypt. The country’s natural access to sea routes through the Mediterranean and Red Seas offers considerable potential for increasing export participation. As a result, Egypt outperforms the average score of the Logistic Performance Index (LPI) of the developing world (Figure 1).[1]

Figure 1: Overall Logistic Performance Index in 2012 (1=low to 5=high)

Logistic Performance Index (LPI) of the developing world

Yet, the country is facing several structural challenges that impede the local private sector, despite efforts to improve the business environment. The 2014 Doing Business Report shows that, in Egypt, firms identify access to finance as one of the major constraints they face. Only 17.4 percent of Egyptian firms have access to a bank loan or line of credit; this ratio for other developing countries is 23.6 percent. The proportion of loans requiring collateral (84.5 percent) and the proportion of investments financed internally (88.5 percent) are still at high levels. Capital market imperfections generate financial constraints that influence firms’ investment decisions, particularly for first-time exporters. Because of the substantial fixed start-up costs of entering international markets, [2] it is reasonable to expect that only firms with sufficient access to external finance or a certain level of productivity can successfully export. Thus, financial constraints provide an additional source of firm heterogeneity that influences export market participation. In the case of Egypt, potential exporters might be prevented from exporting, simply because of their lack of access to external financing.

The literature on the connection between financial constraints and firm export behavior has largely focused on advanced countries, due to the lack of reliable firm-level data from developing countries. In a paper recently published in the Journal of Development Studies, we find that financial constraints act as barriers to trade in Egypt, reducing the intensive and extensive margins of exports. Using a panel of 1,655 Egyptian manufacturing firms over 2003–08, we find that being financially constrained is associated with a decrease in the probability of exporting, a decline in export intensity, and an increase in the length of time spent until the first export market participation. Furthermore, financial liquidity is good for export market participation.

Quantitatively, the export-participation effects of financial constraints found here are relatively more pronounced than those of previous studies in more developed settings (for instance, Greenaway et al. (2007) for the United Kingdom and Bellone et al. (2010) for France).  This result reflects the relative importance of financial constraints in developing countries. But it also suggests that there is substantial room for increasing export market participation in Egypt, by reducing the incidence of financial constraints. Policies for reducing financial constraints can increase export market participation in Egypt through three main mechanisms. [3]

The first channel is through an increase in the extensive margin of exports, due to the negative association between financial constraints and the probability of exporting. The availability of external finance is likely to allow financially-constrained potential exporters to overcome the fixed costs of exporting, thus increasing their participation in foreign markets. Our results show that financially-constrained firms are more than 6 percent less likely to export.

The second channel is through an increase in the intensive margin of exports, because better access to external financing is associated with higher levels of export intensity. Access to finance is also good for incumbent exporters, as it helps them fully exploit economies of scale. Incumbent exporters with better access to external finance can increase exports by increasing the number of exported products for a given destination, or increasing the number of destinations for a given product, or through both channels. They can also increase the export volumes of a given product to a given destination. Our results suggest that, on average, export intensity is 11 to 26 percent lower for financially-constrained exporters compared with other exporters.

The third channel is through the reduction in the time it takes for a firm to enter foreign markets, as a result of a lower incidence of the financial constraints and sunk costs of exporting. Although the trade facilitation situation in Egypt may appear to be unique, it is clear that some lessons can be drawn for other developing countries to the extent that our results can be generalized.

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[1] The LPI is an assessment of countries’ performance on trade logistics, based on a worldwide survey of operators such as global freight forwarders and express carriers.

[2] These sunk costs include learning about foreign markets, meeting administrative standards, and establishing distribution networks.

[3] However, government interventions to broaden access to finance directly should be well-targeted and temporary, due to the high cost associated with the potential risk of missing financially-constrained firms.

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