Corporate Financing and Deleveraging of Firms in India

Unlike other key emerging markets, firms in India are on a deleveraging trail. The paper outlines a systematic inquiry on the applicability of capital structure theories in predicting debt ratios in India. The study is an unbalanced panel data analysis of within-firm effect using data for all available non-financial firms since the economic liberalisation of 1991. We find that although the theoretical determinants are portable from the literature, they do not explain most of the variation in debt ratios of the firms in India. Importantly these theoretical determinants fail to explain the decline in debt ratios of the firms. On the contrary, a majority of these determinants indicate an increase in debt ratios for the firms. Against the backdrop of these controlling factors, the adverse effect of underdeveloped bond markets for credit availability for firms in India is, nevertheless, found quite significant. Following the empirical findings in this paper, we infer that firms in India may be getting adversely affected by not being able to finance their growth with adequate capital. It is possible that they are credit rationed and end up paying higher taxes than required. Among several possible reasons, we put forth that even though banks dominate the credit channels for private sector, the availability of credit is severely restricted and rationed due to several quantitative and qualitative restrictions on bank credit. Further, the bond markets in India are not vibrant enough for firms with adequate credit standing to raise funds on their own. Another possible reason for underinvestment by firms could be the sustained, high cost of funds reflected by higher interest rates fuelled by large public borrowings by the government. The fact that underdeveloped bond markets contribute significantly to declining debt ratios, poses a state engendered moral hazard to developing bond markets in India.