It has been observed that the economic growth cycle coincides with the investment cycle in India. It is found that firm-level leverage could provide early signals about the movements in the investment cycle. Furthermore, a firm’s leverage adversely affects its investment activity after a threshold. Regression results, after controlling for firm’s price to book ratio and operational variables, indicate that the adverse impact of high leverage is predominant on low-growth firms. The initiatives to clean up the balance sheets of banks and deleveraging by non-financial corporates should help in the revival of the investment cycle. The results are consistent with the agency cost of debt and trade-off theory of capital structure, wherein firms set targets for leverage by balancing costs and benefits of debt.
