Economic policy uncertainty and investment-cash flow sensitivity: evidence from India

Purpose This study examines the impact of economic policy uncertainty (EPU) on the investment-cash flow sensitivity (ICFS) of Indian manufacturing firms. Design/methodology/approach This study uses the fixed-effect method to investigate the effect of EPU on ICFS from 2004 to 2019. Findings This study finds that EPU increases ICFS, which is more (less) during the crisis (before and post-crisis) period. The authors also find that the effect of EPU on ICFS is more for smaller, younger and standalone (SA) firms than the larger, matured and business group affiliated (BGA) firms. This study also reveals that EPU reduces corporate investment (CI). Further, the authors find that cash flow is more significant for the investment of financially constrained firms and the negative effect of EPU is more for these firms. Research limitations/implications This study considers the Indian manufacturing sector. Therefore, this study can be extended by analyzing the relationship between EPU and ICFS for the service sector. Practical implications First, this study can be useful for corporates, academicians and government bodies to understand the effect of EPU on ICFS and CI. Second, this study will help corporates to focus on internal funds to finance corporates' investment during the crisis period because EPU increases the cost of external finance which may increase ICFS and reduce CI. Third, lending agencies, investors and stakeholders should also focus on the firm's nature, ownership, size and age because these factors play a crucial role to reduce or increase the negative effect of EPU on ICFS. Fourth, the Government should make appropriate policy measures in terms of concessional interest rates to increase the easy availability of external finance for SA, small size, and young firms to reduce the negative effect of EPU on CI because these firms are considered as more financially constrained firms. Originality/value This study adds new inputs to the current literature of EPU in several ways. First, this study is one of the main studies focused on the relationship between EPU and ICFS (CI). Especially in emerging countries like India, examining this relationship extends previous research. Second, this study also examines the impact of EPU on ICFS for BGA, SA, small, large, matured and young firms as well as crisis and non-crisis periods. Third, this study uses the sample of the Indian manufacturing sector which has emerged the qualities to become a global manufacturing hub and attracting global investors. Therefore, examining the effect of EPU on ICFS for these firms will be more interesting.

Automated summary

This study examines the impact of economic policy uncertainty (EPU) on the investment-cash flow sensitivity (ICFS) of Indian manufacturing firms. The findings show that EPU increases ICFS, particularly during crisis periods. Smaller, younger, and standalone firms are more affected by EPU compared to larger, matured, and business group affiliated firms. Additionally, EPU reduces corporate investment and has a greater negative effect on financially constrained firms.