for countercyclical finance by financially constrained SMEs that otherwise tend to resort to internal funds to finance their operations and investment.<sup>6</sup> The compounded difficulties that SME face in accessing bank finance during an economic slowdown or, worse, in a crisis are well documented in the literature, reflecting banks’ risk aversion against a backdrop of declining profitability and eroding capital. However, this is often counterbalanced by government interventions aimed at maintaining access to finance for SMEs through public guarantees or directed lending, as seen in the wake of the global financial crisis and more recently in the context of the COVID-19 pandemic.

On the other hand, price stability (low inflation), a key sign of macroeconomic stability, is negatively correlated with SME financial inclusion, that is, higher inflation impacts negatively on private sector expectations and incentives, reducing loan supply to riskier borrowers such as SMEs. The share of SME employment in total employment, a proxy for the economic structure of a country, enters the model with a negative sign but is not statistically significant at standard intervals. The relationships between our FCS dummy and the SME financial inclusion index show a strongly negative correlation, suggesting that on average SMEs in FCS countries are relatively more constrained in terms access to and usage of formal financial services. Finally, estimates on income level dummies suggest that SMEs financial inclusion tends to increase with economic development, i.e., higher income levels.

Turning to the macroeconomic environment, our results show the statistically significant importance of informality. SMEs in countries with a sizeable informal economy (as a share of official GDP) tend to have less access and usage of financial services, in light of the negative sign of our proxy for informality. Another statistically significant correlate with SME financial inclusion is natural resources rents (as a share of GDP), our measure of economic diversification. The coefficient for natural resources rents enters our regression with a negative sign, implying that SMEs in countries with higher economic rents find it more difficult to access bank finance, as expected. The coefficient for trade openness enters with a positive sign but is not statistically significant at standard confidence levels.

Financial sector characteristics also affect SME access and usage of finance. The quantity of financial intermediation helps enhance SME financial inclusion, and this is particularly important in FCS countries. Financial depth, measured by the credit to GDP ratio is positively correlated with SME financial inclusion, probably reflecting greater availability of resources for lending. This is more relevant for FCS countries. The quality of financial intermediation is equally important as large government and state-owned enterprise financing can crowd out credit to the private sector, including SMEs. Our results show that countries where the crowding out effect is larger present lower SME financial inclusion outcomes (our proxy for the crowding out effect is positively correlated with the SME financial inclusion index), and this relationship is especially strong for FCS countries. Our results also show that SME financial inclusion is associated with

> 6 The share of investment that is financed internally by SMEs in our sample based on WBES data is 72 percent on average, with no statistically significant difference between FCS countries and non-FCS countries.

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