Apoorv Gupta: The Impact of Relaxing Liquidity Constraints on Small Firm Performance: Evidence from South Africa

We examine the extent to which liquidity constraints are a barrier to firmgrowth
in low-income countries, and study the role that credit policies can play in addressing
them. We combine novel data on small business owners in South Africa’s informal
minibus taxi industry with a program that provided immediate reduction
in payments on the outstanding minibus loan. We find that relaxing liquidity constraints
led to: (i) higher repayments and lower defaults on minibus loan; (ii) an
increase in labor supply; and (iii) better overall financial health. We do not find
any evidence of increase in firm misconduct or risk to passenger safety, suggesting
an improvement in overall welfare. We rationalize these findings using a framework
where penalties arising from late payments under liquidity constraints lead
to future debt overhang, thereby, generating moral hazard in effort.

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