_Low-Income Countries’ Access to Private Debt Markets_ important influence on creditors’ assessment of default risk. However, this is not supported by our regression analysis – “doing business” rankings are statistically insignificant when added to the regressions of the form reported in Table 2. Similar results were obtained using indexes of the overall quality of economic management and structural policies generated by the International Development Association (IDA).<sup>18</sup> The supply / demand dichotomy serves to organize our thoughts on the many potential factors that influence governments’ and corporations’ decisions to access external financing. However, some factors did not fit neatly into this dichotomy. For instance, economies of scale can restrict both the demand for and the supply of external capital. Many countries don’t have the technical capability required to collect and report macroeconomic and financial data that creditors typically use to access default risk. Few institutional investors, fund managers and investment banks are familiar with investment opportunities, particular in some of the smaller low-income countries, and do not have the resources needed to monitor economic and political developments on a frequent basis. Governments and corporations therefore have an incentive to minimize transactions costs by making large infrequent bond issues and syndicated bank loan transactions. This can partly account for the intermittent borrowing pattern observed in most low-income countries.

The size of the corporate sector might also be an important factor, given that bond issuance and syndicated bank loans have become dominated by private and public corporations in developing countries. Surveys indicate that over 40 percent of large firms use external finance, compared to just over 20 percent for small firms (World Bank 2007, figure 1.9). Moreover, large firms finance about 30 percent of their new investment by external finance, compared to only about 15 percent for small firms (World Bank 2007, p. 45). Beck, Demirguc-Kunt and Maksimovic (2004) find that small firms and firms in countries with poor institutions use less external finance, especially bank finance. These empirical findings suggest that private debt flows to low-income countries will increase as the corporate sector matures.

# **_How important is credit rationing?_**

The wide range of factors that influence the demand and supply for external financing makes it is difficult to assess the extent to which external borrowing is limited by the unwillingness of creditors to lend to low-income countries. The existing theoretical and empirical literature on credit rationing provides some insight into this question. In a seminal paper by Eaton and Gersovitz (1981), debtors weigh the potential cost of defaulting (exclusion from private capital markets) against the benefits (a lower debt burden). Creditors are unwilling to lend at any price if they believe that the benefits of default exceed the potential costs. Creditors’ assessment of debtors’ “willingness to repay” is complicated by several additional factors such as moral hazard, adverse selection and asymmetric information. Estimates of the incidence of credit rationing vary considerably. Eaton and Gersovitz found that 80 percent of developing countries were credit constrained in 1970 and 1974, suggesting that the credit-rationing constraint binds quite often.

> 18 The Resource Allocation Index generated by the International Development Association (IDA) is comprised of sub-indexes on economic management and structural policies, which are designed to gauge the extent to which policies and institutions foster growth and poverty reduction in 78 countries that are eligible to receive concessional funding from the IDA.

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