Small Business Lending Programs Can Slow Growth and Create Financial Constraints : Evidence From India’s PSL Program

Programs to direct finance to small firms are ubiquitous. We develop evidence of unexpected side-effects of these programs. Exploiting discontinuities in program eligibility in India’s PSL program, we show that targeted lending programs can slow growth, paradoxically creating financial constraints for the very small firms whose constraints the program aims to relieve. The growth distortion is more pronounced when program strictures bind more. The results show that financial constraints matter for small businesses. They gain financing through targeted lending programs but in doing so, distort their growth trajectories by remaining small for longer periods of time