Financial constraints on small firms’ growth: pandemic lessons from Iran

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Iman Cheratian and
Saleh Goltabar
March 19, 2024

How does access to finance affect the growth of small businesses? This column presents new evidence from Iran before and during the Covid-19 pandemic – and lessons learned by micro, small and medium-sized enterprises.

In a nutshell

Micro, small and medium-sized enterprises in Iran that received financial support and remained unaffected by the pandemic demonstrated greater growth; for MSMEs that were affected by the pandemic and which did not receive external financing, the reduction in growth was more pronounced.

Enhancing access to financing for the growth and sustainability of MSMEs is crucial, particularly during times of crisis like Covid-19; the challenges faced by MSMEs in emerging economies are large, especially in the context of a sanctioned country grappling with a global pandemic.

To enhance the growth and sustainability of MSMEs, policy-makers should improve access to finance by offering government-backed loans, subsidies and alternative financing channels; foster a favourable business environment; and implement specific policies in times of crisis.

Numerous studies have illustrated that financial constraints have a significant impact on the survival, growth and performance of micro, small and medium-sized enterprises (MSMEs).

Due to limited resources and heavy reliance on bank loans with high interest rates, MSMEs become particularly vulnerable to disruptions during economic crises. Unlike large firms, MSMEs struggle to handle fluctuations in demand, especially when revenues decline and the need for bank credit increases. This places them at a disadvantage in terms of production growth and market share compared with larger firms, thereby reducing their chances of survival (Bottazzi et al, 2014; Bakhtiari et al, 2020; Cheratian et al, 2023; Cheratian et al, 2024).

The Covid-19 pandemic caused significant disruptions to the global financial ecosystem, affecting financial markets, business financing and the world economy. Consequently, the private sector has faced various challenges, including liquidity shortages, the risk of bankruptcy and income losses. Firms in urgent need of liquidity have encountered difficulties in obtaining credit, as banks have been hesitant to lend to those with low credit quality and asset values (Khan, 2022).

In Iran, Covid-19 has had a profound impact on an economy that was already grappling with oil dependency, international sanctions, negative growth and high inflation. During the first two months of the outbreak, Iranian firms experienced a 50% decline in sales growth. By June 2020, 34% of business owners reported a decrease in income exceeding 75%. Most business owners felt they did not have sufficient cash reserves to cope with the reduction in revenue.

The Iranian government was also facing financial difficulties due to declining revenues resulting from sanctions and falling oil prices, which limited the resources available for protectionist policies (Borimnejad and Dehyouri, 2022; SRTC, 2020).

Surveying small firms in Iran

In a recent study, we analysed the responses to 486 questionnaires sent to a sample of 500 Iranian MSMEs over a period before and during the pandemic. To ensure representation and diversity, random sampling was used to select five of the country’s provinces: Tehran, Khorasan Razavi, Kerman, Mazandaran and Ilam. These provinces were chosen due to their geographical dispersion and varying economic maturity.

The survey was conducted by the Academic Center for Education, Culture, and Research (ACECR) from December 2019 to September 2020. The respondents were owners or senior managers of the firms, and face-to-face interviews were conducted to collect data from the selected firms in each province.

The study focused on analysing the performance of sales and production growth as key indicators. In this context, a value of ‘1’ signified growth, while ‘0’ indicated no growth. Among the 486 respondents, 121 reported experiencing growth in sales, while 126 respondents reported growth in production.

The survey also explored the presence of financial constraints using binary variables. Specifically, the variable ‘Access to finance’ received a value of ‘1’ if loans were fully funded, while ‘non-access to finance’ obtained a value of ‘1’ if loans remained unfunded. Impressively, around 20.9% of the respondents reported having access to finance, while a substantial 68.5% faced non-access to finance.

The study also looked at the influence of Covid-19 as a moderating variable. Notably, a significant 37% of businesses were affected. In this aspect, a value of ‘1’ denoted the impact of the pandemic, while ‘0’ indicated no discernible effect.

Other factors considered in the study were firm age (with 53% of firms being over 11 years old), firm size (with 60% of firms having 10-50 employees), economic downturn (with 315 firms facing bankruptcy), technology acquisition (with 65% of firms having access to technology), owner education (with 65% of owners having university degrees), human capital (with 66% of firms hiring new employees and 52% adjusting their workforce) and labour training (with 57% of firms providing training courses).

Results and implications

Our analysis reveals a positive relationship between access to finance and the growth of MSMEs in terms of sales and production. The study demonstrates that limited access to external financing hampered growth significantly. Younger firms operating for one to five years exhibited greater growth compared with their older counterparts (those operating for six to ten years).

In addition, access to technology, owner education, and new employment had positive and significant effects on firms’ growth. On the other hand, facing bankruptcy and labour adjustment negatively affected sales and production growth for MSMEs.

Our study also sheds light on the crucial moderating role played by the pandemic in the finance-growth relationship for MSMEs in Iran. The results indicate that MSMEs that received financial support and remained unaffected by the pandemic demonstrated greater growth compared with those affected by this global crisis. But for MSMEs that were affected by the pandemic but did not receive external financing, the reduction in growth was more pronounced.

These findings emphasise the significance of enhancing access to financing for the growth and sustainability of MSMEs, particularly during times of crisis like Covid-19. This is important to bear in mind when discussing the challenges faced by MSMEs in emerging economies, specifically within the context of a sanctioned country grappling with a global pandemic.

To enhance the growth and sustainability of MSMEs, policy-makers should make three key policies their priorities:

First, they should improve access to finance by offering government-backed loans, subsidies and alternative financing channels.
Second, they should foster a favourable business environment by reducing bureaucratic hurdles and stringent requirements.
Third, it is crucial to implement crisis-specific policies, such as emergency funding and debt relief, to support MSMEs during challenging times, such as the pandemic.

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