Constraints to Private Investment in a High-Growth Environment: Firm-level Evidence from Ethiopia

Private investment remains relatively weak in Sub-Saharan Africa despite recent improvements in investment opportunities and infrastructure. The median firm in nine African countries has zero investment in any given year since 2005, similar to observations in the early 1990s when most economies in the region were performing poorly. To better understand this outcome, this paper analyzes investment decisions of a panel of Ethiopian firms using initial bank ties and firm size to capture heterogeneity in potential credit constraints. We find that relationships with lenders are persistent and firms with rare access to credit respond vigorously to investment opportunities than constrained ones. Credit access also shortens average durations of investment inaction and lackluster investment episodes. While access to credit increases with firm size, small firms with bank ties are at least as responsive to investment opportunities as large firms are. Such relationships tend to be particularly relevant for import competing and single-product firms that are prone to liquidity constraints as compared to their protected and multi-product counterparts.