Political connections, investment inefficiency, and the Indian banking crisis

Abstract

This paper examines the investment inefficiency of politically connected firms (PCFs) in the Indian context. We argue that the investment inefficiency of PCFs may reveal the Twin-balance sheet (TBS) characteristics of the banking crisis through interactions between PCFs and Government-owned Banks (GOBs). Using the unique dataset on PCFs in India and the panel quantile regression, we find that the strong PCFs exhibit a higher level of investment inefficiency than the weak PCFs. We also highlight the advantages of quantile regression in an overinvestment analysis. The findings may help trace the link between the investment boom of the mid-2000s and the subsequent twin-balance sheet crisis. The results are entirely new in the Indian context.