that this proportion is positively related to financial development and to legal system indicators, suggesting that access to finance at the firm level increases their growth. More recently, Beck and others (2002) used WBES survey data to study the effect of financing constraints on growth using subjective evaluations of entrepreneurs of the financing and legal constraints they face. They find that firms reporting higher financial and legal constraints and corruption grow more slowly, and this effect is especially strong for small firms.

Mexico is an important case to study the issues mentioned above. It not only lags behind comparable countries in terms of domestic financial development, but also presents a sustained contraction of domestic financial depth as measured by credit- and liabilities-side indicators of financial depth. Bank deposits to GDP in the country declined from 25 percent in 1997 to 17 percent in 2002. Similarly, over this period, M2 to GDP fell from 28 percent to 22 percent. Overall, credit to the private sector, including lending by private and development banks, nonbanks, and foreign sources, declined from 43 percent to 40 percent, attributed to a contraction of bank lending.<sup>4</sup> Private bank lending to the private sector fell from a peak equivalent of 16 percent of GDP to 9 percent.<sup>5</sup> Development banks also decreased their lending from 3.4 percent of GDP to 2.2 percent. Until the Tequila crisis in 1995, banks had been the main source of credit to the private sector in Mexico. Since then, nonbank and foreign financing have kept pace with GDP growth, providing an alternative source of financing in addition to retained earnings. As in other countries, there is a trend for financial intermediation to move away from bank deposits and credit to nonbanking instruments and institutions. Enterprises and people tend to increasingly finance themselves from nonbank entities, such as investment companies (SOFOLES), savings and loan societies, credit unions, leasing companies, factoring companies, nonbank liabilities of listed Mexican companies, debt issues of unlisted companies, and credit-card financing provided by retail businesses. In recent years, nonbank institutions and foreign sources (liabilities contracted abroad) have become important providers of credit to the private sector (17 percent and 12 percent of GDP in 2002, respectively).

At the micro level, there are concerns that economic agents such as enterprises and individual entrepreneurs face increasing levels of credit constraints, hampering their ability to make investments. Available survey data indicate that both enterprises and entrepreneurs participate in loan markets to a limited extent, especially in formal markets. For example, a survey of rural entrepreneurs in three Mexican states finds that 24 percent participated in loan markets, of which 7 percent borrowed from formal lenders in 1993-1994 (World Bank 1995). A recent survey of small- and medium-size enterprises in Mexico City finds that only 30 percent used bank loans in the past 12 months (World Bank 2002). The Bank of Mexico, which carries out a quarterly survey of 600 firms about their financing sources, reports that about 20 percent of enterprises surveyed use bank loans.

Previous empirical evidence on the incidence of credit constraints in Mexico indicates its pervasiveness. Using a survey of farmers in the states of Sonora, Guanajuato, Puebla, and Tlaxcala, Stanton (1994) studies the access to credit by farmers in rural Mexico, estimating a disequilibrium model of supply and demand for loans (without distinguishing formal and informal sectors). The author finds that supply is significantly increased by the presence of collateral and the number of loans received in the past (likely evidence of good credit history), whereas demand is influenced by the usage of machinery in farming. The model predicts that over 80 percent of farmers receive the amount of credit that is determined by the supply function, and thus are credit constrained. Furthermore, educational attainment, size of land holdings owned, and usage of credit for land improvement have a positive effect, whereas nonfarm

> 4 For private and development banks only direct financing is included.

> 5 Nevertheless, credit conditions appear to be improving in 2003: credit to the private sector grew at positive rates every month in 2003 with year-on-year growth rates of at least 9 percent.

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