On the chessboard of economic decision-making, uncertainty is the invisible opponent. It clouds judgment, delays moves and sometimes paralyses the game altogether.
In a recent paper an IIMB economist examines how India Inc behaves in turbulent times and why a credible policy environment is necessary for businesses to thrive
On the chessboard of economic decision-making, uncertainty is the invisible opponent. It clouds judgment, delays moves and sometimes paralyses the game altogether.
In her recent working paper, economist Anubha Dhasmana with the Indian Institute of Management Bangalore, investigates how Indian firms navigate this fog. Titled “Economic Policy Uncertainty and Underinvestment in Indian Firms”, Dhasmana’s paper examines a question that has long hovered over India’s corporate corridors: Do businesses hold back when they cannot read the signals from New Delhi? And if they do, what is the cost?
Dhasmana’s approach is rooted in a now-global attempt to quantify what was once thought immeasurable: uncertainty. Borrowing from the methodology pioneered by economists Scott Baker, Nicholas Bloom and Steven Davis, she uses an index that tracks how often Indian newspapers mention terms like “economic”, “uncertain” and policy-related words such as “fiscal policy”, “monetary policy”, or “PMO”. This Economic Policy Uncertainty (EPU) index becomes the compass by which she charts the sentiment of India Inc.
Overlaying this with firm-level data from over 1,400 manufacturing companies across 32 industries between 2001 and 2023, Dhasmana constructs a composite view of how companies behave in turbulent times. The backdrop is familiar: a post-liberalisation India that has seen both sprints and stumbles, from the 2008 global financial crisis to the twin policy shocks of demonetisation and GST, and then Covid-19’s economic whiplash. Each of these moments, she finds, marked a visible spike in the EPU index.
One of the paper’s central contributions is its attempt to measure “underinvestment”, which is the investment that firms should have made but did not. Using a fixed-effects panel model that accounts for company-specific traits (like age, size, debt-equity ratio, cash flow and book-to-market value), Dhasmana calculates the expected level of investment and compares it to the actual numbers. If reality falls short, it is tagged as underinvestment.
The pattern that emerges is clear: when policy uncertainty rises, investments fall. The causality is not just correlation; it is embedded in corporate behaviour. Early spikes in EPU trigger caution; firms wait, watch and delay. But the story takes a twist when uncertainty stays high for too long.
Dhasmana draws on the theory of strategic growth options to explain what happens next. At high levels of uncertainty, the logic flips. Firms begin to invest despite the fog. Why? Because hesitation might allow competitors to seize the market first.
In such moments, investment is not a statement of confidence in today’s economy, but a hedge against being outflanked tomorrow. It is a pre-emptive move in a game where the rules are unclear, but the rivals are watching. Better to enter the market now, even blindly, than to be locked out later.
At high levels of uncertainty, the logic flips. Firms begin to invest despite the fog. In such moments, investment is not a statement, but a hedge against being outflanked tomorrow
This nuanced insight helps explain what otherwise looks like a contradiction: EPU initially depresses investment, but at extreme levels, it may provoke bursts of risk-taking. Not because the fog has lifted, but because the cost of inaction has risen higher.
The paper also explores the consequences of this hesitation, or boldness, on a firm’s performance. Using two standard metrics, return on assets (ROA) and Tobin’s Q (the ratio of a firm’s market value to the cost of replacing its assets), Dhasmana assesses whether holding back or pushing forward pays off.
The results are mixed. In periods of low uncertainty, disinvestment may offer short-term performance boosts with leaner, more cautious firms doing better, But in times of sustained uncertainty, underinvestment backfires. Firms that fail to adapt lose ground. The short-term safety of sitting on cash becomes a long-term liability.
Dhasmana’s paper, though steeped in regression tables and economic jargon, ultimately paints a sobering portrait. India’s policy landscape is not just unstable but also destabilising. The rising trend in the EPU index, with its peaks and plateaus, is not an academic abstraction. It is the ambient noise to which every investor, small or large, must attune themselves.
What is most striking is that this is not a tale of shocks alone. Yes, demonetisation, GST and Covid-19 created momentary spikes. But Dhasmana’s data shows a slow, steady climb in background uncertainty, a new normal, not an exception. For firms, this means adapting not just to individual disruptions but to a chronic unpredictability that shapes strategic thinking itself.
In a country where capital is scarce and expectations are sky high, the cost of chronic hesitation is rarely calculated. Dhasmana’s work nudges policymakers to do just that. The paper does not just warn that uncertainty reduces investment. It shows how the rules of the game shift under prolonged unpredictability, sometimes tilting the field in favour of firms that are bold, reckless or simply bigger.
Ultimately, the paper is less about the psychology of business and more about the structure of the state. A clear, stable and credible policy environment is not a luxury, it is infrastructure as important as roads or ports. And without it, the best-laid plans of Indian enterprise will continue to live in limbo, waiting for the skies to clear.
(The writer is an assistant professor of economics, Barasat Government College, West Bengal)