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How the Financing of Firms Affects Prices

November 6, 2018 by Victoria Nuguer Leave a Comment


Firms in the developed world rely heavily on bank credit. But firms in developing countries, and particularly those in Latin America, rely much more heavily on trade credit–i.e. credit from their suppliers –and that has immense implications for pricing decisions and inflation.

Most studies that have looked at inflation in emerging economies have examined the role of domestic supply shortages, exchange rate movements, oil prices and external shocks.

In a recent study, Alan Finkelstein, Andrés González, Jessica Roldán-Peña and I take a different angle. We focus on the key role that trade credit has for price-setting in emerging markets and how that can allow firms greater flexibility to smooth out prices.

The growth in trade credit and  prices

Our study, which appears to be the first to examine this aspect of price-setting, arrives at some surprising conclusions. We find that in emerging economies what really matters for firms’ prices is trade credit growth. In fact, looking at other variables like bank credit, leverage, revenue and others, we find that trade credit  growth is the only thing that affects pricing decisions.

Firms in developing economies rely more heavily on trade credit because they have much more limited access to formal credit markets, especially overseas. So instead of getting their financing mostly from banks, they depend more on credit from their suppliers — buying now and paying later — with no interest charged as long as they pay on time.  Data from the World Bank Enterprise Surveys reveal just how important this phenomenon is in developing countries. While firms in Israel and Germany finance 23% and 42% of their working capital with trade credit respectively, that figure stands at 67% in Mexico, and 50% in Peru.

Greater flexibility for firms

This reliance on trade credit can be especially tricky for small, informal firms. The high interest rates they suffer if they do not pay their suppliers within the stipulated time can be highly punitive. But bigger shares of trade credit give larger firms in developing countries certain advantages. Specifically, it gives them flexibility to respond quickly to a domestic shock, like the introduction of a more efficient technology, by buying fewer inputs from their suppliers and reducing prices. That would be difficult if one’s financing came from a bank where the interest rate had been fixed.

We observed directly how this flexibility brings down prices. We studied 39 of the listed firms on the Mexico Stock Exchange. We looked at their balance sheets and confidential data from the National Institute of Statistics, INEGI, that feed into the consumer price index and constructed price indexes for each one of them. We found that a one percent increase in trade credit growth for these large firms brought prices down 0.8%. For those of the 39 with a trade-to-bank credit ratio above the median, that one percent increase cut prices 2%.

Financing that challenges central banks

A larger reliance on trade credit can potentially make the job of central banks more difficult. In developed economies, central banks can increase the rate at which they lend to commercial banks and, in turn, those banks lend to firms — a dynamic that gives central banks a direct tool by which to influence inflation. In developing countries where more credit comes from suppliers rather than banks, that monetary tool needs further study.

The point is not to say that one system is better than another. Each type of financial structure has its advantages. The key point is that the financing structure of firms matters deeply, and that if we want to understand the dynamics of inflation and get a better grip on monetary policy, we must know from whom firms are borrowing.


Filed Under: Macroeconomics and Finance Tagged With: #CentralBanks, #firms, #Inflation, #LatAm, #Mexico, #monetarypolicy

Victoria Nuguer

Victoria Nuguer is a Research Economist in the Inter-American Development Bank’s Research Department. She holds a Ph.D. from École Polytechnique Fédéral de Lausanne in Switzerland and a bachelor’s degree from the Universidad de Buenos Aires in Argentina. Prior to joining the Bank in May 2017, she spent nearly three years as a Research Economist in the Bank of Mexico. Victoria’s main research agenda focuses on building dynamic stochastic general equilibrium models to explain key financial transmission mechanisms in closed and open economies. For closed economies, she has focused on the propagation of financial shocks from the housing sector to the rest of the economy. Regarding open economies, Victoria has studied the international transmission of financial shocks from advanced to emerging economies through the bank lending channel. Recently, she has been working on understanding the strategic interaction between monetary and macroprudential policies and on the role of trade credit when firms set prices in emerging economies.

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