Allocation of capital in the post-liberalized regime: a case study of the Indian corporate sector

The paper investigates the trends in the allocation of capital in an emerging economy, India, during the post-financial liberalization regime. In contrast to the conventional wisdom that financial liberalization leads to better allocation of funds, the study could not find any obvious evidence of increase in efficiency over the reform period, especially during the early years of reform. Further, the study highlights the disturbing trend of convergence of efficiencies across various strata of firms towards a lower level over the reform period. This paper rationalizes the decline as a result of excessive capacity creation in certain industries, financed by cheap external sources of finance, without any consideration of return or demand conditions. This paper, as a policy recommendation, highlights the importance of creating appropriate institutions prior to pursuing financial liberalization in developing countries like India.