Demand of External Finance by Manufacturing SMEs in Addis Ababa, Ethiopia

Abstract: Poverty can be reduced if more good jobs are created. Small- and medium-sized enterprises (SMEs) are good job creators, but there are few such firms in the countries that would need them most. Limited access to finance is frequently suggested as a reason why these firms fail to prosper, but recent evidence indicates that only expanding financial supply does not sufficiently improve the status for the SME sector. This paper contributes to the discussion with a demand-side perspective, by examining how SMEs finance themselves and what drives their demand for external finance. I use a panel dataset of Ethiopian manufacturing firms from 2012-2013 to investigate what type of firms use bank loans. Secondly, I also conduct interviews with managers to explore financial behaviour in the SME sector. The results show that standard capital structure theories to some extent can explain financial demand, but perceptions and attitudes among managers also matter. To improve financial status for SMEs, strengthening contract enforcement and lowering the perceived barriers to the banks should be policy implications for Ethiopia and developing countries in general.