This paper analyses the determinants of fixed investment in the Indian Private Corporate Manufacturing sector for the period 1973-2002, using Annual Survey of Industries Data. It is argued that economic policy of a nation is crucial in determining the investment behavior in developing countries rather than the traditional factors like output and profit. Against the background of the financial sector deregulation initiated in India since 1991, this study makes an attempt to analyze whether the traditional factors or the economic policy variables plays a major role in determining investment behavior. A reduced form equation derived from the neoclassical investment theory is used for the empirical analysis. Financial Liberalization Index is constructed for India for the analysis. The results show that, the traditional determinants like output and profit still plays a major role in determining corporate investment rather than the policy variables. Though aggregate financial liberalization and more prominently domestic financial liberalization produced an environment conducive for investment, it could not succeed in creating a sustained increase in capital formation in the post-reform period. In other words, firms consider the demand factor, internal liquidity position and past investment decisions etc., as the major indicators for future investment. The only index which shows strong positive association with corporate investment is index of money market liberalization. It is also found that there is significant negative association between index of capital account liberalization and corporate investment. The negative and significant relationship with index of capital account liberalization and investment raises many concerns over the credibility of external (international) financial reforms.

The empirical literature on economic growth consistently showed that the rate of accumulation of physical capital or investment is an important determinant of economic growth. More importantly, in developing countries, as evidenced by many studies, it is the private investment that plays a greater role than pubic investment in determining economic growth1. The studies on the determinants of private investment in developing countries, against the traditional theories of investment, focused on the role of government policy andtried to derive an explicit relationship between the principal policy instruments and private investment (Blejer and Khan, 1994; Guncavdi et. al., 1998; Sioum, 2002). Recent theoretical and empirical studies have produced results consistent with the idea that the economic policy of a nation is crucial in determining the domestic investment behavior (Blejer and Khan, 1994, Greene and Villaneuva, 1991, Sioum, 2002, de Melo and Tybout, 1990). These studies emphasized the role of financial sector development on private investment and provide a framework for understanding the effects of changes in economic policies on private investment.