Private investment has risen as a share of GDP in recent years, an important driver of the region’s impressive growth since 2003. Nonetheless, investment-to-GDP ratios remain below those in other regions. Moreover, investment has not increased uniformly across all countries. The rise in the aggregate investment-to-GDP ratio has been driven especially by increases in Colombia and Venezuela and by the recovery in Argentina. Private investment in other countries, such as Brazil and in the Caribbean region, has risen less over this period.
Against this background, a recent study by IMF staff seeks to understand the factors behind the performance of private investment in the region in recent years. The paper is available via the Internet at: http://www.imf.org/external/pubs/ft/reo/2008/WHD/ENG/wreo1008.htm.
The study first examines at an aggregate level the determinants of the private investment in the region over the longer period of 1980-2007. It finds that increased macroeconomic stability has played an important role in encouraging private investment in the past while the impact of other macro factors, including the recent terms of trade improvements, is less clear.
Macroeconomic factors alone, however, cannot quite explain why the LAC region has invested less than some of the other emerging market economies. Indeed, inflation and volatility in the larger regional economies are now comparable to other emerging market countries. Also, cross-border risk premia have fallen sharply to levels that are only marginally higher than spreads in emerging market comparators. Previous studies have pointed to the importance of diverse structural and institutional features for private investment, including the role of financing constraints.
This study extends the analysis to revisit the role of financing constraints using a new cross-country firm-level data in the period since 2003, during which the region’s resilience and capital market access have increased substantially. It finds that firms in Latin America, especially smaller firms, continue to face important financing constraints that hold back investment, despite the recent gains on macro stability.
- Cross-country firm-level data analyzed show that financing costs in the LAC region have fallen some over the last decade. However, they remain high in comparison with other regions, in fact almost double those facing firms in the Asian region. Small firms in the LAC region face higher financing costs than larger firms. But this financing premium for smaller firms in the LAC region is higher than in Asia (this is evident from the wider gap between the distributions for small and large firms in the LAC region, as compared to those in Asia).
- A more rigorous analysis of the role of financing constraints is to empirically test the effect of a firm’s stock of cash on its investment (the idea being that firms that are financing constrained keep more cash on hand, all else equal). This analysis shows that in general, cash stock has a highly significant and positive effect on investment, and when firm size is included in the regression, the estimated coefficient is large and positive. These results confirm that financing constraints remain very much a factor affecting corporate investment in the LAC region, especially for smaller firms.
All told, this study emphasizes the importance for growth and investment of preserving hard-won gains on low and stable inflation and the need to press on with the development of banking systems and capital markets to ease financing constraints