Global capital flows and financing constraints

Finns often cite financing constraints as one of their primary obstacles to investment, Global capital flows, by bringing in scarce capital, may ease host-country firms' financing constraints. However, if incoming foreign investors borrow heavily from domestic banks, multinational firms may exacerbate financing constraints by crowding host-country firms out of domestic capital markets. Combining a unique cross-country firm-level panel with time-series data on restrictions on international transactions and capital flows, we find that different measures of global flows are associated with a reduction in firm-level financing constraints. First, we show that one type of capital inflow-direct foreign investment (DFI)-is associated with a reduction in financing constraints. Second, we show that restrictions on capital account transactions negatively affect firms' financing constraints. We also show that DFI inflows are associated with lower sensitivity of investment to cash flow for firms without foreign assets and for domestically owned enterprises. Finally, the results indicate that these effects are stronger for low-income than for high-income regions. (c) 2004 Published by Elsevier B.V.