# **1 Introduction**

What drives international trade? What hampers its growth? Academics and policy makers devote a lot of attention to these questions. Multiple factors have been under the lens but typically different causes have been examined separately. In this paper, we investigate the role of financial and real sector elements on trade dynamics using firm-level data from 24 countries in the Eastern Europe and Central Asia (ECA) region. We document the relative importance of adjustment at the extensive (number of exporters) and intensive (quantity of exports) margins during the period from 2002 to 2013. We then analyze the relative importance of credit as opposed to demand shocks in the firm’s decision to export and the amount of exports in a formal econometric setting.

We find that demand shocks tend to significantly affect the decision to export as well as the volumes exported. Conversely, credit constraints appear to play a more limited role. These results tend to be robust to a wide range of specifications. However, there are differences in the relative importance of these elements when we consider the type of export margin (extensive and intensive) as well as the time period (before or after the crisis). Domestic demand shocks matter across all specifications as they influence firms’ decision to export and the amount of exports. Conversely, foreign demand shocks significantly influence the intensive but not the extensive margin, and their role becomes more pronounced when we distinguish between pre- and post-crisis periods. Finally, credit constraints only play a role in the intensive margins and mainly when we do not take into account the role of the financial crisis. The firm’s subjective perception that financial constraints are a hurdle for business appears to matter more than the objective inability to secure a loan after applying. The evidence is robust to controlling for possible endogeneity.

The paper contributes to two branches in the literature examining the roles of finance and demand shocks in international trade. The literature has mostly examined both roles separately and finds that they are important to trade. Our paper will examine both roles together and finds that demand shocks may be more important to international trade. The paper is closely related to Nguyen and Qian (2014), that examines the roles of demand shocks and credit constraints on firms in the ECA countries. Focusing only on the financial crisis period (specifically 2009), the authors show that demand shock is the main factor for a worsening in firm performance (sales, capacity, and employment) is the decline in demand for the firm’s goods. They highlight the role demand shocks play in the financial crisis over credit constraints. Our paper extends this discussion by examining the roles demand shocks and credit constraints have on firm export behavior and how the relative importance of these roles changes over a longer time period that includes the financial crisis.

Various studies document the importance of finance for international trade transactions: financial institutions not only provide trade finance through payment insurance and guarantees to exporters, they are also key suppliers of services such as the evaluation of counterparty default risk. Trade finance is a powerful catalyzer of international trade, Auboin (2009) estimates that about 90% of international trade transactions rely on some form of trade finance.

The global financial crisis has heightened the interest in the impact of credit crunches on trade.

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