The determinants of trade credit use: the case of the Tanzanian rice market

Abstract

Most small businesses in the developing economies suffer from a lack of access to formal external finance. One important alternative source of finance for these entrepreneurs is trade credit. Applying a unique data-set containing data on specific trade relations between rice wholesalers and rice retailers in Tanzania, we analyse the determinants of trade credit demand and supply in this market, using a simultaneous equation modelling approach. The analysis shows that while the demand for trade credit is primarily determined by the extent to which retailers need external funds, supply is mainly driven by wholesalers’ incentives to attract and keep clients. Moreover, wholesalers’ willingness to provide credit increases if they have better information about the possibility that the customer will fail to repay the credit.

Keywords:

• trade credit
• disequilibrium model
• rice market
• Tanzania

JEL Classification:

• L12
• L14

Notes

¹ Table A1 in Appendix provides an overview of all the variables used in this study, along with the sign we expect to find in the analysis.

² When retailers and wholesalers were asked for the price of trade credit, they consistently answered that the same price is paid if trade credit is provided and that no interest rate or other costs are made.

³ Maddala and Nelson (1974) have shown that in the absence of information about the price adjustment process and assuming that the error terms ε_S and ε_D in Equations 1 and 2 are normally distributed, the model described in Equation 4 can be solved using the maximum likelihood method. We optimize the log-likelihood function derived in Maddala and Nelson (1974) using the Newton–Ramsey iterative procedure. Further details on how the optimization of the log-likelihood function has been carried out are available on request from the authors.