In this paper we analyse the effect of business cycle fluctuations on firms capital structure using a large panel of non-financial firms in India. In particular, we explore the dynamics of firm leverage across business cycle expansions and recessions for financially constrained and unconstrained firms. We find that the leverage of unconstrained firms exhibits counter-cyclical dynamics. Leverage of financially constrained firms does not show any cyclical pattern. These results are robust across different empirical methods of estimation. A healthy financial system is one where all firms are able to access the external debt market especially in a downturn. Our analysis shows that in the Indian financial system, external capital goes only to a certain category of firms. This has important policy implications for further developing the domestic financial markets and institutions.