Effect of Access to Finance and Investment Climate on Resource Misallocation and Productivity of Small and Medium Enterprises (SMEs) in India

Indian small and medium enterprises (SMEs) face resource misallocation problems that affect their total factor productivity growth. This study examines how difficulties in accessing finance and the business environment impact input misallocation and productivity, utilizing the World Bank Enterprise Survey (2022) database, which includes data from 6,348 enterprises. Firm productivity and input misallocation are measured using stochastic frontier analysis and Hsieh and Klenow’s model. Potential endogeneity arising from overdraft facilities and working capital is addressed through various robustness tests and endogenous stochastic production frontier analysis. The key findings suggest distortions in the allocation of capital and labour, with capital misallocation being more significant. Access to finance significantly influences firm productivity and the marginal productivity of both capital and labour. Additionally, investment climate factors, such as annual security costs and quality certifications, play a critical role in reducing the capital productivity gap, while power outages negatively impact firm efficiency and productivity. Therefore, policies aimed at supporting SMEs in India should focus on improving financing availability and addressing investment climate challenges.