Review of Market Integration

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Dec 7, 2010 - firms can not only better serve domestic markets but also start to exploit foreign markets. .... (after the United States and China and just ahead of Japan) in 2006 .... faster and are directed more towards the developed markets such ..... deregulatory process especially as there is little experience in India.

Review of Market Integration

India in the World Economy: Role of Business Restructuring Raj Aggarwal Review of Market Integration 2010 2: 181 DOI: 10.1177/097492921000200302 The online version of this article can be found at:

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India in the World Economy: Role of Business Restructuring Raj Aggarwal As the size and importance of its economy increases, India is becoming more integrated with the world economy. The process of deregulation and the economic reforms started in the early 1990s seem irreversible and continue to accelerate. In recent decades, transactions costs in India have been declining, especially as India deregulates its business environment. Consequently, Indian businesses are moving away from being widely diversified and vertically integrated business groups and are becoming focused, efficient, and often larger firms. In addition to the resulting corporate restructuring and increased domestic M&A, many Indian firms are investing overseas and becoming nascent multinationals. These changes mean that the global integration of the Indian economy will continue to increase.

Keywords: India, world economy, M&A, Indian economy, restructuring, BRIC India, finance

1. Introduction The Indian economy has been on a deregulatory path since at least the early 1990s and the process of economic deregulation

Acknowledgements: The author is grateful to T. Agmon, R. Dossani, D. Haake, M. Serapio, S. Sjögren, and his colleagues for useful comments on earlier versions, but remains solely responsible for the contents. Review of Market Integration, Vol 2(2&3) (2010): 181–228 SAGE Publications: Los Angeles • London • New Delhi • Singapore • Washington DC DOI: 10.1177/097492921000200302



and external opening seems to be accelerating. These changes are forcing Indian business to become domestically and globally competitive and it is forcing major changes in corporate struc-tures and management cultures. A number of trends and forces are accelerating this process. First, India is increasing investments in communication and physical infrastructure. Rapid implementation of internet-based technologies is occurring in India, allowing its organisations to connect efficiently to each other and to the world. Second, deregulation and global opening of the Indian economy are now firmly established and unlikely to reverse (though its speed may vary) regardless of the type of government in power. In addition, the levels of literacy and education are rising rapidly in India. All of these changes speed up business processes, eliminate many impacts of distance, make prices more transparent, and generally reduce search and other deadweight costs of business transactions. Third, technology and superior management know-how are spreading from a few pioneering companies that are becoming globally competitive to the wider Indian business environment. Not only are each of these forces individually very powerful, but they are mutually reinforcing, so the overall effect is now becoming transformational and exponential. As deregulation and global opening of the economy forces many Indian companies to become more efficient and globally competitive, they will inevitably turn for assistance to new internet-based technologies and India’s increasingly better-educated workforce. With technology, Indian firms can not only better serve domestic markets but also start to exploit foreign markets. Indeed, technology enables globalisation and globalisation makes technology more profitable (Aggarwal 1999). In this process, the first few successful Indian companies will serve as centres of excellence, as role models, and as sources of management know-how for other Indian firms. This spread of management know-how and technology is greatly aided by the gradually increasing pace of economic deregulation in India. As the use of technology spreads to second- and third-tier firms, it will fuel further demand for technology and improve the efficiency of everlarger proportions of the Indian economy. These developments in REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228

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the institutional and technological environment of business are likely to provide an important boost to India’s long-run economic growth rate.1 However, these mutually reinforcing positive developments also mean a number of associated changes in the business environment that are likely to be very disruptive. Most large Indian firms will need to restructure and will be forced to become more efficient and focused (not necessarily smaller) firms by redefining their core competencies. Redefining and focusing on core competencies is often a difficult and slow process. As some firms become more efficient, they are likely to drive out firms that are slow to change or that remain inefficient. However, corporate bankruptcies, especially large ones, always have a tendency to get messy, frequently with political fallouts. Many firms are also expanding globally with rising numbers and levels of cross-border mergers and acquisitions. These globally competitive Indian firms will bring newly acquired foreign technology and management expertise into their domestic operations, thus putting further pressure on other domestic Indian firms to remain competitive. Indian businesses certainly face a period of accelerated change, but may also exploit many novel opportunities. This article briefly reviews the bases of recent Indian economic growth in the next section with special emphasis on the deregulation of the business and financial sectors in India. The role of technology and its relation to declining transactions costs in India is also analysed in this section along with the development of the implications of declining transactions costs for business strategy and structure. The third section covers developments related more directly to the globalisation of the Indian economy and business. This includes a brief review of the globalisation of the business and financial sectors in India followed by a discussion of the rise of domestic and cross-border mergers and acquisitions in India and by Indian companies overseas. This section ends with a short discussion of the nature and economic foundations of the emerging set of Indian multinational companies. The last section covers some concluding comments. This article makes a contribution to our understanding of the Indian economy by relating the internal process of economic REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228



deregulation in India with increasing deployment of technology and the resulting economic efficiency and how these internal processes lead to the increasing pace of external mergers and acquisitions and the globalisation of India business and economy. In the past these internal and external processes have often been viewed separately. This article also contributes by extending our understanding of the nascent phenomenon constituted by the rise of Indian multinational companies.

2. Growth and Focusing of Indian Business Firms India has been an important part of the world economy. After all, Columbus was looking for a shorter route to the wealthy nation of India when he accidentally found the native-American inhabitants of the Americas, who, as a result, received the moniker of ‘Indians’. As noted by a recent writer: In the beginning there were two nations. One was a vast, mighty and magnificent empire, brilliantly organized and culturally unified, which dominated a massive swath of the earth. The other was an underdeveloped, semi feudal realm, riven by religious factionalism and barely able to feed its illiterate, diseased and stinking masses. The first nation was India and the second was England. The year was 1577. (Von Tunzelmann 2007) While India produced about 25 per cent of the world’s industrial output in 1750, this figure fell to just 2 per cent by 1900 (Clingingsmith and Williamson 2004). As we all now know, India and China fell behind while the Western countries surged economically with industrial revolutions and economic growth during the age of empires. The situation changed again in the latter half of the twentieth century, following the decline of vast overseas empires after World War II. The economies of Japan and then Southeast Asia grew rapidly in the post-War era in the twentieth century. Now that China and India are growing at even more rapid REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228

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rates, many contend that this is perhaps a reorientation of the world economy so that Asia accounts for about half the global economic output once again as it did in the eighteenth century. India has been on a quest to increase its percentage of the world economy, since the middle of the twentieth century, when it achieved independence from its uninvited guests and when its share of world GDP had declined to somewhere between 1 and 2 per cent. Indian economic growth was slow in the beginning and was driven (or held back depending on your view) by the Fabian socialists that came to dominate the post-independence Indian government. Indian real GDP per capita is now rising on average by approximately 7½ per cent annually, a rate which doubles real GDP per capita within a decade. This figure contrasts dramatically to the former annual growth of GDP per capita of just 1¼ per cent during the three decades from 1950 to 1980. Faster growth has resulted in India becoming the third-largest economy in the world (after the United States and China and just ahead of Japan) in 2006 (when measured at purchasing power parities) accounting for nearly 7 per cent of world GDP (OECD 2007). The modern Indian economy is indeed quite different from what it was in the middle of the twentieth century.

2.1 Deregulation and Indian Economic Growth India today is a large and strategically important democratic country with a growing service sector and significant industrial (including nuclear and aerospace) capabilities. At over a billion people, India has the second-largest population in the world and is a major military and economic power in Asia. In the last decade, India’s real economic growth rate has exceeded the growth rates of most other economies (with the notable exception of China, its neighbour to the north). Nevertheless, India faces many challenges in maintaining its high growth rate. 2.1.1 Development Dilemma While there already are some world-class businesses based in India (such as Tata Motors, Reliance Industries, etc.), most Indian businesses have until recently been better at dealing with the Indian REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228



bureaucracy than with global competitors. This is now changing and the deregulation of Indian business means that they now face increased competition from not only other domestic companies but also foreign companies. What are the forces driving this process of deregulation and is it reversible? India has the largest population and economy in South Asia but it is surrounded by unstable and often hostile neighbours. In the north, it has unresolved territorial conflicts with China—conflicts that led to a humiliating defeat in the 1962 border war with China. In the West, Pakistan and India, both nuclear powers, have fought a number of wars and Kashmir remains a divisive issue. In the east, Myanmar and Bangladesh are both poor and somewhat unstable states. In the south, Sri Lanka has been unstable for decades with an on-and-off war against the Tamils in its north. Within India there are Maoists and other groups that continue to often violently challenge the authority of the state in selected rural areas. These external and internal military threats impose a huge burden on the Indian economy. India has large numbers of distinct linguistic and ethnic groups; there is much poverty, and large regional variations in income and wealth (e.g., Budhwar 2001). The 28 Indian states, many of which are distinguished by linguistic and ethnic groups, are quite different from each other, and very independent. As in the United States, Indian states work in a confederacy with the central government in New Delhi and New Delhi has little control over intra-state matters. In spite of these variations, India has a well-established democracy, and Indian cultural values seem consistent with the requirements of a democracy. In contrast with other countries at low levels of economic development, the level of interpersonal trust is high in India exceeding the level found in many developed societies. India also ranks with many of the developed countries in measures of freedom and opportunities for self-expression (Inglehart 2000). Reflecting these values and unlike most developing countries, Indian democratic institutions seem robust having withstood many shocks over the last half century. Thus, it is reasonable to assume that Indian policies for economic development, including the process of deregulation, must be consistent with, and can REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228

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depend on, a stable democratic political structure (Das 2001). The 2009 reelection of the current governing party reinforced this assumption. However, in some ways in the early years India’s newfound democracy proved to be a burden. At independence from Britain in 1947, almost all of the Indian leadership received training in England by (well-meaning) Fabian socialists. These leaders were responsible for setting up the state machinery designed for the bureaucratic control of the Indian economy—leaving this bureaucratic machinery essentially unchanged until the 1980s. One of the reasons why the Indian bureaucracy had been so draconian is that until 1990 it was felt (incorrectly) that such bureaucratic control was the only way a democracy could keep in check inequitable wealth distribution and defuse poverty-driven political unrest. A high population growth rate requires ever increasing resources for food and shelter, and as the Indian government tries to reduce the number of people living in poverty, it must attempt to redistribute some wealth through taxes and regulations. However, as these tax and regulatory burdens increase, economic growth rates inevitable drop. So any democratic Indian government faces the same basic developmental dilemmas; how much economic growth should it give up for a more even distribution of wealth and income, and how much of this redistribution should be centrally planned and how much be left to the markets? 2.1.2 Nature of the Indian Economic Growth Indian economic success in recent decades (since the 1990s) has been driven by a number of traditional macroeconomic factors. Savings rose from 23.4 per cent of GDP in 2000 to 35.4 per cent in 2007. During the same period, investment rose from 24 per cent of GDP to 36.3 per cent of GDP driving significant increases in productivity. Though fiscal deficits have been coming down, successive reductions have become harder to achieve. It is clear that the government’s goal of achieving a zero revenue deficit by 2009 will not occur; meanwhile public debt has climbed to over 80 per cent of GDP. However, external debt is low, with a large share in long-term debt and so traditional pressures on the exchange rate because of high external debt are nonexistent. In addition REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228



India’s foreign exchange rate reserves in February 2009 were fairly substantial at almost a quarter trillion (239 billion) US dollars (Jha 2009). The Indian workforce is younger than in most countries, is getting better nutrition with the agricultural self-sufficiency (and export ability), is increasingly literate (two-thirds in 2001 and rising), and is now better educated with rising secondary and collegiate graduation rates. Services and manufacturing industries dominate the Indian economy, contributing 55 per cent and 28 per cent respectively to GDP. While agriculture contributes the remaining 17 per cent to GDP, 60 per cent of the population depends on it (while declining in recent years, around 22 per cent of the population is consequently still below the poverty line). Public-sector ownership in industry is still extensive in India. In the so-called organised sector of the economy, the generally underperforming state-owned enterprises produce 38 per cent of business-sector value added (OECD 2007). Many Indian companies in manufacturing industries are producing significant quantities of high-quality manufactured goods for export markets. More interestingly, many global MNCs see India as a base for developing low-cost manufactured products for export to not only other developing countries but also the developed countries. In addition to information technology companies, this is increasingly true of companies in the consumer product, automobile, two-wheeler, health care, and pharmaceuticals industries. India is home to some of the largest R&D centres globally by companies in these industries, such as General Electric, Ford, Honda and Philips.2 While the Indian Railways is the largest system in the world and is widely admired for its efficiency and profitability (the World Bank seeks it as a partner in other developing countries), India suffers from poor transportation and utility infrastructure (Lamont 2009; Bintliff 2009). There continue to be great shortages of electrical power in India but many large businesses have already invested in decentralised electric generation equipment. Nevertheless, for the foreseeable future, there will continue to be great demand for electrical power and for generating sets in India. India is planning on significant increases in power generation capacity particularly REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228

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in green power generation. For example, while as of 2009 nuclear energy accounted for only 2.7 per cent (4,100 megawatts) of total power generation capacity of 152,000 megawatts, India is currently building six nuclear reactors and is seeking bids for the construction of another six reactors to augment its current complement of 17 nuclear reactors.3 Similarly, as of 2009 even though India only had about five megawatts of solar power capacity, the Indian State of Gujrat is planning the world’s largest Solar power complex of 3,000 megawatts and, according to the Ministry of New and Renewable industry, subsidies for solar power will be increased as part of the goal to have 20,000 megawatts of installed solar power in India by 2020 (Leahy and Sood 2009; Sharma 2009). Similar strides are planned in the installation of wind power in India (Suzlon, an Indian wind power company is among the world’s five largest wind power companies). In addition, logistics and transportation services will also have to grow very rapidly because of deregulation. This includes much higher growth rates in air, rail, and road travel and transport. India also faces significant challenges in its ability to manage national water resources especially as its water table is falling rapidly due to over-pumping. Over half of India’s annual precipitation occurs in just 15 days of the increasingly unpredictable monsoon season. In addition, there are wide regional variations and much water is poorly managed. India needs to trap and store more water, channel it to where it is most needed, and use it more efficiently. Also, a large part of India’s food production is now wasted because of poor transportation and poor distribution infrastructure. While India has made significant progress in reducing the proportion of people living in poverty, it has not done as well with improving the lives of its vast rural population. As one example, there is little progress in reducing malnutrition among children (who do not vote)—a problem with serious long-term consequences. While India’s GDP per capita grew fourfold between 1992 and 2006, malnutrition among children below age three declined only slightly from 52 per cent to 46 per cent.4 Fortunately, there seem to be many market-driven developments that are solving some of the problems faced by rural residents REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228



in India. These include the use of internet technology to deliver government services in rural India, the use of cell phones by rural residents to obtain better prices for their production, and the rise of rural warehouses run by the national commodity exchanges that buy farm produce at close to national prices.5 With growing worker shortages for IT jobs in the big cities, rural India has also started to benefit from outsourcing jobs involving data entry and other low-tech portions of the Indian outsourcing boom.6 In addition, the recently implemented public works–based National Rural Employment Guarantee Act has been credited with the surprisingly strong rural workforce demand even with the global recession-related economic slowdown compounded by the poor 2008–09 monsoon rains (Samand 2009). Regardless, there is little doubt that the middle class in India is growing rapidly. India has always been one of the largest markets for gold in the world and the Indian central bank became one of the top 10 holders of gold reserves with its recent acquisition of 200 tons of gold (about 8 per cent of annual global gold production) from the IMF. It has been estimated that India now has well over 100 million people living at the same standard as the US middle class.7 Defined somewhat more liberally, the middle class in India is now over 400 million and growing rapidly. In addition, as has been noted elsewhere, the large numbers of poor people in India also present a very large market for goods and services tailored to their needs and buying power (Aggarwal 2006; Prahalad 2005). More importantly, the rapid growth in this class has meant a significant jump in the demand for consumer goods. As there are considerable inefficiencies in the distribution and retail of these goods, there is a great potential in India for large retail chains. Another area, which is likely to witness great growth, is Banking and Finance, especially as inadequacies in these fields are holding back much of India’s development. Finally, Indian manufacturing is now becoming world class and manufactured exports from India can be expected to grow sharply in the future. Indeed, Indian exports of automobiles not only exceed that of exports from China, but they are growing faster and are directed more towards the developed markets such as in Western Europe (Business Week 2009). REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228

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2.2 Deregulation of the Indian Financial Systems Globalisation of the Indian economy has been critically facilitated by its deregulation. India’s deregulation has not only enabled the growth and expansion of their private sector, enabling it to be a more effective competitor in the global arena, but it has also lowered the many barriers to the globalisation of the Indian economy and financial system. 2.2.1 Indian Banking System Deregulation Indian banks are tightly regulated and India is considered to be under-banked (Rosta 2009). While there has been a huge expansion in rural credit availability from traditional money lenders and microfinance institutions in recent years, India remains an under-banked country and there are continuing but generally inadequate efforts to deregulate Indian banking. Banking entry is generally tightly controlled in India. Banking reform accelerated in 1990 from a position in which state-owned banks controlled 90 per cent of bank deposits and channelled an extremely high proportion of funds to the government, interest rates were determined administratively, credit was allocated on the basis of government policy, and approval from the Reserve Bank of India was required for individual loans above a certain threshold. However, by 2006, the share of bank deposits that must be lent to the government through the mechanism of the Statutory Liquidity Ratio was reduced to 25 per cent while the proportion of deposits that must be deposited with the Reserve Bank through the Cash Reserve Ratio is now 6½ per cent. Competition in the banking system was also increased by allowing new private banks, including foreign ones, to enter the market. At present, FDI and foreign portfolio investment in public sector banks is limited to an aggregate cap of 20 per cent; for private banks the limit is 74 per cent (but shares with voting rights are capped) while for insurance companies the limit is 26 per cent. 2.2.2 Deregulation of the Indian Financial Markets The introduction of a new regulatory authority for capital markets in 1992, the Securities and Exchange Board of India (SEBI), was a REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228



key step in the reform of capital markets. In 1994, the government encouraged the creation of the National Stock Exchange (NSE), a competitor to the Bombay Stock Exchange (BSE). The new exchange enabled participants from across the country to trade in one market. The new exchange was one of the first stock exchanges in the world to have a corporate structure so that it can have private owners. It now has foreign shareholders (New York Stock Exchange and various banks) up to the maximum (26 per cent) allowed by Foreign Direct Investment (FDI) regulations. It rapidly became the largest market in India and, the third-largest exchange in the world, measured by the number of transactions. The NSE is also now the eighth-largest derivative exchange in the world in terms of trading volume. In addition, other reforms such as new clearing and settlement institutions were introduced to reduce trading costs in India. An integral part of the new architecture was the creation of a centralised counter-party for transactions. This was established as a subsidiary of the NSE and resulted in the elimination of counter-party risk in the market. At the same time, a 1996 law allowed the creation of a new depository institution for holding all stocks in electronic form greatly reducing settlement risk. Overall, these reforms created a national market in shares, eliminating price differences across the country. Transactions costs have fallen significantly in India and now are comparable to those in OECD countries, leading to a marked rise in stock market turnover (OECD 2007). However, in contrast to equity markets, the government and corporate bond markets are much less developed. The Reserve Bank dominates the government bond market, which not only regulates the market, but is also the principle issuer in the primary market. The corporate bond market is regulated by the SEBI and, for public issues, is subject to considerable documentation requirements, resulting in the almost complete absence of traded corporate bonds and the domination by private placements. The Indian bond market is dominated by public sector issuers. Overall, total outstanding corporate bonds amounted to 1.5 per cent of GDP in 2005, with the total funds borrowed abroad by Indian companies amounting to almost another 1 per cent of GDP (OECD 2007). REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228

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2.2.3 Deregulation of Risk Management Trading in derivatives on the NSE started in 2000 and the Indian market is now the 10th-largest market for futures contracts on single stocks and indices in the world and the largest market for futures on single stocks. This follows a 77-fold increase in the turnover of equity derivatives between the years ending March 2002 and 2006. Overall, total turnover in over-the-counter debt derivatives is estimated at USD 1 billion per day, with perhaps double that turnover in currency futures. A significant offshore market exists in the currency futures and a new exchange market is being established in Dubai. A range of foreign exchange hedging instruments has been introduced, including forwards, swaps and options; however, FX futures contracts are still not permitted. During this decade, a complete overhaul of the commodity exchanges occurred. Markets were fragmented and illiquid, suffering from being restricted to inessential products for a long period. However, starting in the mid-1990s, the commodity market regulators began to reform these markets. Initial attempts were unsuccessful but three new markets were created in 2000, based on the architecture of the NSE. These markets became viable even more quickly than the new stock exchange. Although there are 94 commodities traded, gold and silver account for half of turnover. By 2006, the gold market became the third-largest derivative market for gold in the world (OECD 2007). As this brief review indicates, the Indian equity markets are quite well-developed and the value of Indian equity as a proportion of global equity valuation rose more than twelvefold from about 0.2 per cent in 1989 to 2.5 per cent in 2007. India’s equity market is an efficient allocator of capital. Bad management is punished severely by the stock market, obliging companies to use capital efficiently or perish. As a result, India requires much less capital per unit of growth than many countries like China, where capital is allocated mainly by the state.8 The successful development of the equity market also helps to explain the change in the equity-debt mix in the financing of listed Indian firms and the entrance of foreign portfolio investment. There has been a shift from debt to equity in recent years, from a 1.82 debt-equity ratio in 1992 to a 1.06 ratio in 2004 (Patnaik and Shah 2006). REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228



2.3 Economic Deregulation and Technology 2.3.1 Deregulation and Recent Indian Economic Growth The current process of economic deregulation started in the early 1990s. At that time, India faced a number of pressures to deregulate its economy. First, annual economic growth had increased to about 5 per cent from the anemic 3–3.5 per cent annual rate of the prior decades, but had stalled. Most importantly, India had borrowed heavily to finance its growth in the 1980s and now faced critical balance of payments crises with the prospect of international default for the first time since independence in 1947. Second, the Berlin wall had fallen and many socialist and communist states had failed by 1989 followed thereafter by a strong international movement towards market driven economies. Among India’s neighbours, the Soviet Union was falling apart; meanwhile, China was having much success with the economic deregulation it had started in the early 1980s. Third, even big business in India, that had long accepted protected markets in exchange for draconian bureaucracy, now wanted opportunities for growth (e.g., Percy 1992). This combination of internal and external pressure resulted in the first wave of economic deregulation in India in the early 1990s, freeing up enough of the large amounts of pent-up demand among Indian consumers that it was considered a major success by government, industry, and consumers (e.g., Joshi and Little 1996). The initial success of deregulation in the early 1990s paved the road for subsequent deregulatory moves, most of them meeting with success. Consequently, by now all the major political parties, business and industry, and consumer groups, are all committed to the deregulation and the gradual global opening of the Indian economy. Indeed, India is not only committed to membership in the World Trade Organization (WTO), but also to a leadership role in the organisation. However, as can be expected in any democratic country, there continues to be much public debate in India about the distribution of economic gains and the nature, sequence, and speed of the deregulatory process. However, there is now little doubt about the need to deregulate the Indian economy. A related advantage of deregulation is the decline in corruption due to greater transparency and reduction of bureaucratic power.9 REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228

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2.3.2 Economic Role of Computer Technology India has many resources that account for the extraordinary success of its computer and software industry. India has a superb educational system and graduates one of the largest numbers of scientists and more than a quarter million engineers annually; and many Indian engineering institutes are truly world class.10 In addition, English is the medium of instruction for higher education, and with the revolution in electronic communications, Indian knowledge workers, who earn much less than their counterparts in the developed world, have easily become part of the global economy. Finally, many non-resident Indians (NRIs) are investing in and moving back to India, and are actively participating in transferring capital, technology, and managerial expertise from the Western countries to India. The Indian outsourcing (software) industry employed only about 1.6 million people in 2009 (about one-tenth of 1 per cent of India’s population) but it is a high-growth industry. In 1998, Indian outsourcing revenues were about US$ 4 billion growing to US$ 60 billion by 2009 and are expected to double over the next five years (Lamont 30 December 2009). While the Indian Software industry is relatively small compared to other more traditional industries, it seems to have had an influence on the Indian economy and the Indian image overseas far greater than indicated by its size. More than one-third of Fortune 500 companies now have computer software development operations in India and this proportion is increasing as more US, European, and Asian companies are starting to follow this initial group. Further, because of its large English-speaking population, India is becoming the back office and customer service division for large numbers of European and US companies who have been setting up these operations in India. These activities are creating jobs and adding to domestic economic growth. Indeed, India is seeing shortages of well-trained and world-class management talent, along with escalating salaries for qualified people. Indian software companies have been able to raise substantial amounts of money in global financial markets, such as New York, London, and other financial centres. Table 1 lists the largest Indian REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228



Table 1: Selected Indian ADRs∗ Traded in the United States Company



Wipro Satyam Computers Infosystems Silverline Technologies Rediff ICICI ICICI Bank HDFC Bank Mahanagar Telephone Sterlight Industries Tata Motors Dr Reddy’s Laboratories


Information Systems/Software Information Systems/Software Information Systems/Software Information Systems/Software Information Systems/Software Financial Institution Financial Institution Financial Institution Telecommunications Industrial Industrial Pharmaceuticals

Note: ∗American Depository Receipts.

companies that trade as depository receipts in the United States. As this table shows, software companies currently dominate this list. In addition to the New York Stock Exchange and the NASDAQ in the United States, securities of Indian companies also trade on the London and other European stock exchanges. As global financial markets become accustomed to Indian software companies, other Indian companies are increasingly finding it easier to meet global accounting and financial standards and raise money in global markets. A great deal of this capital flows back to India, supporting the Indian [currency] rupee. A strong rupee means the Reserve Bank of India can keep interest rates lower than it could otherwise. Such lower interest rates are likely to encourage growth throughout the Indian economy. In addition, the growth of any new technology or industry creates a number of ripple effects—with these ripple effects being larger for new technologies and increasing with widespread penetration and adoption. For example, the rapid growth of the Indian software and computer services industry has led to increased rates of growth in other (e.g., supplier) industries, that is, in industries such as telecommunications, computer hardware, and other products and services consumed by the software industry that has been widely considered a prime source of economic growth (e.g., Helpman 1998; Mokyr 1990). Technology transfer from the REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228

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software and other leading edge industries will benefit some areas and industries earlier than others. Additionally, there are likely to be industry variations in initial increases in growth rates. Driven by the software industry, the computer hardware industry will also continue to see very high rates of growth. The growth of the software industry will also continue to add to the infrastructure pressures. For example, in the telecommunications industry, India is rapidly being wired up with large amounts of fibre optic cable. Indeed, among developing countries, the amount of fibre optic cable installed in India is second only to China.11 Consequently, most rural and urban centres in India will soon have broadband access via fibre optics. The widespread availability of broadband will lead to a major increase in economic growth rates as these communities connect to each other and to the global economy. However, Indian consumers are not just waiting for broadband—they are being increasingly connected to each other and the world via the cell phone. Indeed, India is now one of the largest and fastest growing cell phone markets in the world even though some feel that the government is too slow to make regulatory changes in this area.12 Nevertheless, cell phones have penetrated all parts of India including rural areas that have limited or no access to landlines. Not only is India leapfrogging old landline technologies, it is doing so at shockingly low cost. Indian cell phone costs are the lowest in the world, recently being as low as ` 0.30 (less than US$ 0.01) per minute billed in one-second increments.13 In fact, the rural ubiquity of inexpensive (90 per cent) pre-paid phones (as low as ` 100 or US$ 2.17) has meant a great deal of economic empowerment and growth in rural areas as, for example, farmers can now call for crop prices in various nearby markets and obtain the best prices for their output.14 This is one example of the numerous ripple effects of high-tech penetration in a country.

2.4 Transactions Cost Economics and Changing Indian Corporate Structure 2.4.1 Changes in Corporate Structure and Strategy Commerce in India until recently was a mixture of heavily regulated small and large private businesses and large state-run REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228



businesses. In addition to large numbers of small businesses, the Indian economy has also been characterised by the presence of many large business groups. Unlike businesses in the Anglo-Saxon countries like the US, UK, Canada, or Australia, the larger, private Indian businesses can be characterised as widely diversified and often vertically integrated business groups. For example, of the largest 5,446 stock exchange listed companies in India, 1,821 or about a third are group-affiliated companies. These group-affiliated companies are on average 4.37 times the size of non-group affiliated companies (Khanna and Yafeh 2007). While there is some evolution, a changing mix of large business groups still dominates many Indian economic sectors. The Indian private sector has a long history—a history that includes many prior periods of considerable change. Table 2 lists the 10 largest business groups over two 30-year periods ending in 1999. As this table shows, these largest business groups are becoming more important to the Indian economy, specifically because the average size of these groups grew at a faster rate than the Indian economy. Interestingly, being large was no guarantee of continued success as there are few commonalities in these lists of the top 10 business groups in India for 1939, 1969 and 1999. Tata was the only one in all three lists while Martin Burn was in the 1939 and 1969 lists and Birla was in the 1969 and 1999 lists. All others were new in each list (Piramal 2001). Thus, the current period of business change is not new. However, the rate of business change in the next five to 10 years is likely to accelerate and much turbulence will mark this period. This dominance of group-affiliated companies is quite understandable as the Indian commercial environment has been much less than perfect and the Indian markets for many corporate inputs have been quite inefficient (see Table 3). This has meant that Indian companies found it more efficient to internalise many of these markets, that is, not buy these inputs as needed from external suppliers, but manage them as internal company resources. Consequently, many Indian business houses have been widely diversified and vertically integrated (e.g., Khanna and Palepu 2000). However, as the Indian economy progressively deregulates and feels the impact of new information technology, external markets REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Avg. Size 2∗∗ 8.5%

7.3% 7.8%

CAGR11∗ Tata (505) Birla (456) Martin Burn (153) Bangur (104) Thapar (99) Nagarmull (96) Mafatlal (93) ACC-Tata (90) Walchand (81) Shriram (74) 175



12.8% 9.6%


Tata (22,345) Wipro (18,439) Ambani (16,060) HCL (9,275) Ranbaxy (7,970) Bajaj (7,667) Aditya Birla (7,114) Hero (3,715) Satyam (3,210) Punj (3,173) 9,897


Source: Piramal (2001) and author’s calculations. Notes: ∗CAGR: Compound Annual Growth Rate (1 = 1939–69, 2 = 1969–99); calculated for the average and for the groups that survived in the top 10 from one period to the next. ∗∗Figures in parenthesis indicate asset base in 1939 and 1969 and market cap in 1999, on March 31, measured in Crores of Rupees (1 Crore = 10 million).

Tata (62) ∗∗ Martin Burn (16) Bird (12) Andrew Yule (12) Inchcape (11) ED Sassoon (10) ACC (Tata) (9) Begg (6) Oriental T&E (6) Dalmia (6) 15




Table 2: History of the Top Ten Business Groups in the Indian Economy



Table 3: Relative Market Efficiency for Corporate Inputs in the Indian Economy Market

United States




Equity Focused Wide Disclosure External Monitoring Market for Corporate Control

Bank Focused High Debt Ratios Group Monitoring Limited Market for Corporate Control

Underdeveloped Illiquid Weak Monitoring Very Weak Market for Corporate Control


Business Education Highly Mobil General Skills

General Education Not Mobil Firm-Specific Skills

Low Education Low Mobility Low Skill Levels


Liability Laws Enforced Efficient Information Activist Consumers

Liability Laws Enforced Efficient Information Few Activists

Limited Liability Weak Enforcement Little Information Few Activists

Moderate Predictable Low Corruption

High Less Predictable High Corruption

Regulation Low Predictable Not Corrupt

Source: Based on information in Khanna and Palepu (2000) and author analysis.

are increasingly becoming more efficient and the advantages of vertical integration and diversification will decline and eventually disappear (e.g., Rajan, Servaes and Zingales 2000). These changes will force significant and sometimes sudden restructuring among the large and major conglomerates in India. Next we consider the forces driving these changes in corporate structure. 2.4.2 Transactions Costs and Corporate Boundaries A business firm can be considered a nexus of formal and informal contracts between various stakeholders, that is, customers, employees, suppliers, investors and other appropriate entities. These formal and informal contracts govern the many tasks performed by a firm. Some of these tasks are performed by units and entities within a firm while others may be performed by units or entities outside the firm.15 The firm manages internal tasks through bureaucratic hierarchies or other internal mechanisms. External tasks are managed through outsourcing contracts and market processes. The number of functions and types of resources that the firm acquires, develops, and manages internally versus those that it hires or purchases externally depends on which total acquisition REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228

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costs are lower; total acquisition costs reflecting production costs and the costs and risks of the transactions necessary to acquire such resources (e.g., Coase 1937; Williamson 1985). Transactions costs generally consist of search, negotiation, contracting, and enforcement costs of establishing a business relationship so that exchange of goods, services, and compensation can take place. Contracts that eliminate all opportunistic behaviour are difficult or impossible to write because of bounded rationality, performance measurement difficulties, and information differences (asymmetry) between the parties to a contract. Thus, some transactions are best carried out in a market economy while others must be internalised and conducted within a firm. If external markets for these resources are inefficient and associated transactions costs are high enough, the firm will find it more profitable to internalise such markets by making such resources a part of the firm (e.g., Caves 1980). Thus, the boundaries of a firm are determined by the differences in external versus internal transactions costs. Transactions costs and market efficiency also depend on supporting institutions that can provide the formal and informal rules governing the exchange process (North 1990). Such institutions reduce transactions costs by reducing uncertainty and by providing a stable framework for forming ethical and other expectations regarding the behaviour of participants in a transaction and limiting incidents of opportunistic activity. Transactions costs are likely to be higher in an uncertain and changing environment. The nature and efficacy of social institutions, such as the legal system and the ethical framework of a society, can play a critical role in reducing uncertainty or the costs of search, negotiation, or contracting (e.g., LaPorta et al. 1997). Similarly, strong systems of public disclosure of financial information, business monitoring, investor protection, and corporate governance required by well-developed capital markets can also reduce transactions costs (e.g., Levine 1997). As many of these institutional features that reduce transactions costs occur more frequently in high-trust societies, transactions costs are likely to be lower in such high-trust societies (Fukuyama 1995). In addition, poorly functioning markets for corporate control, managerial talent, and technology can increase transactions costs. REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228



High-trust societies are likely to have lower transactions costs and large, well-diversified and vertically integrated business groups are less likely to dominate commerce in such countries. Indeed, empirical evidence suggests that business groups serve as risk sharing mechanisms when capital markets are underdeveloped, but not when capital markets are well developed (Aggarwal and Zhao 2009; Khanna and Yafeh 2007). 2.4.3 Changing Transactions Costs With economic deregulation, many expect transactions costs to decline. Most deregulation reduces the costs associated with managing the many business interactions within the bureaucracy. The replacement of bureaucratic controls with market mechanisms generally means the move towards more efficient organisations and markets.16 In addition to the drop in transactions costs within the scope of economic deregulation, transactions costs in India and in most other countries are also dropping due to the rapid application and implementation of new, internet-based technologies in businesses. These new technologies can reduce transactions costs significantly, as they certainly reduce the search and information costs involved in transactions. In many cases these technologies can also reduce negotiation, contracting, and monitoring costs associated with business transactions. On the other hand, these new technologies may demand larger scale for efficiency and the ability to leverage network effects. Thus, the application and implementation of these new internet-based technologies can be expected to lead to significant changes in corporate boundaries in most countries. As one consequence, corporate outsourcing has exploded with almost no regard to physical distance. As discussed earlier, India benefits greatly from this trend towards corporate service outsourcing. 2.4.4 Strategic Implications for Business Groups As in many developing countries, large business firms in India have generally been widely diversified and vertically integrated. However, the advantages of wide diversification and vertical integration are generally likely to disappear as markets become REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228

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more efficient and transactions costs decline. In such cases, the disadvantages of a group structure may become a liability, for example, bounded rationality in managing diverse operations, sheltering of weak operations, and appropriation of minority shareholders’ assets. It should be noted here that while transactions costs reductions point to more focused business organisations, other forces point to increased advantages of size. It would be difficult for many of the smaller participants in a market to have the economies of scale necessary to deploy many of the new technologies, invest in building national brands, or develop the R&D capabilities to survive in a deregulated business environment. Thus, the advantages of increased economies of scale and scope, especially in an increasingly deregulated, globalising, and growing economy like India, may favour growth of company size. Thus, many business groups may grow in size for scale and network economies, but at the same time they will have to restructure and become more focused.17 Given the increased level of competition due to economic deregulation, such groups no longer should or can stay in many unrelated businesses. But, such changes in business structure can be very challenging indeed. Not all markets in a country are likely to become efficient at the same rate and firms would have to monitor these changes and assess their impact carefully. In addition, such firms would have to redefine their core competencies carefully in view of the changed market efficiencies. However, this process of restructuring is unlikely to be entirely smooth. As in the past, some large unfocused business groups may become unprofitable and even disappear. Some firms are likely to undertake strategic reassessments faster and more accurately than other firms. Such firms are then likely to drive many of the slower adjusting firms out of business. Thus, there is likely to be consolidation in many industries as the smaller less efficient players are driven out. To support this, effective and appropriate bankruptcy procedures and a well-functioning legal system that can enforce property rights must be in place. However, failing firms, especially if they are large, are likely to create political and economic disruptions, and regulators and policy makers will have to stand firm under these circumstances against calls to slow, stop, or reverse the REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228



deregulatory process especially as there is little experience in India with large-scale bankruptcies. Indeed, major indications of the lack of necessary restructuring in India are inadequate bankruptcy laws and procedures along with the remnants of industrial regulation that still affect the operation of Indian firms and constrain their flexibility to adjust to new economic conditions. Along with lengthy, cumbersome liquidation procedures, these regulations often hinder firms from eliminating unprofitable product lines. As noted by the World Bank (2005), India’s bankruptcy rate was, 4 per 10,000 firms, compared with 15 in Thailand and 350 in the United States. If patterns in firmentry and exit are consistent with these observations, industrial deregulation will be accompanied only very slowly by industrial restructuring. Another major channel for business restructuring is a liquid market for corporate control in an environment of well-developed financial markets. Friendly and hostile mergers and acquisitions are an important tool for corporate restructuring.18 Well-developed financial systems and capital markets need legal systems that clearly define and enforce property rights, an independent accounting profession and associated regulations to encourage high levels of public disclosure, and market regulations to prevent self-dealing and misuse of fiduciary responsibilities and encourage the fair and equal treatment of all shareholders (e.g., Aggarwal and Harper 2001). In addition to enforceable and well-defined property rights, the development of financial and capital markets also depends on a reliable and transparent system of regulation. Such regulation is needed to ensure adequate and uniform disclosure, to prevent self-dealing and other misuses of fiduciary responsibilities in the financial industry, and to ensure fairness in financial markets and the financial soundness of securities exchanges and firms in the financial system. The orderly development of financial markets generally involves the progressive introduction of trading in securities of increasing risk and complexity. For example, the first securities markets generally involve short-term securities issued by the government, followed by trading in longer-term government debt instruments, bonds and shares of well-known and large REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228

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private firms, bonds and shares of smaller lesser known private firms, and then derivative securities. In addition to facilitating corporate restructuring, efficient financial markets have been shown to encourage economic growth (e.g., Levine 1997; Rajan and Zingales 1998). While India may have adequate laws and regulations in place, its judicial system seems very inefficient and perpetually clogged, so that justice is certainly not swift in India. Judicial enforcement of property rights is so slow in India that it is often considered ineffective. In many cases, corporate restructuring in India is likely to be impeded by the lack of professional management especially in family run firms. While the situation is changing, members of the controlling families still run a number of large business houses. Lack of professional management not only impedes restructuring, but it also acts as a deterrent to potential changes in corporate control. Economic deregulation and the development of financial markets are likely to hasten the transition from family control and management to non-owner professional management.19 Corporate governance in India would have to improve as owners and corporate managers are likely to find it increasingly difficult to ignore the rights of minority shareholders as India financial markets develop and open up to foreign participation. 2.4.5 Implications for Indian Business Structure The adoption of new technologies and advanced management knowhow in India has been spearheaded by the development of the globally active and competitive computer software industry in India. Technology and management practices from this lead industry leak out or transfer to other industries in India thereby increasing their global competitiveness. These developments further support and reinforce the process of economic deregulation. Thus, economic deregulation and the adoption of new technologies and superior management in India are mutually reinforcing forces that are likely to accelerate. This improvement in the institutional environment of business in India is equivalent to increases in organisational capital; increases that supplement reinvestments in the form of physical and financial capital. Thus, these changes can be expected to boost the rate of growth of the Indian economy. REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228



However, these institutional changes also mean significant and often disruptive changes for large well-diversified and vertically integrated business groups in India. As the markets for corporate inputs become more efficient, the advantages of diversification and vertical integration will decline, disappear and even reverse. With such changes, Indian businesses will have to become more focused and efficient (not necessarily smaller). This transformation of large Indian businesses is unlikely to be entirely smooth, will require a continuing firm commitment to economic deregulation, and clearly has important implications for policy makers and managers in business and industry.

3. Global Integration of Indian Business and Economy The integration of the Indian economy and its financial system, with their global counterparts, has increased steadily, particularly since the reforms of the early 1990s. This globalisation of the Indian economy has been facilitated by the continuing deregulation of the Indian financial system. Indeed, global integration could not happen without such deregulation. For example, the Indian government has committed firmly to the adoption of International Financial Reporting Standards (IFRS) by Indian companies by 2011. An important mechanism that enables the globalisation of the Indian economy is the growing market for corporate control in India and the resulting rising incidents of M&A among Indian firms. The skill sets and abilities developed in domestic M&A in India are now being increasingly used by Indian firms to extend their operations overseas. Such activity is an important part of the globalisation of the Indian economy. Globalisation of Indian financial markets is just starting. Movement of capital in or out of India is generally prohibited, except for specific exceptions the government allows. Inward FDI is monitored, and foreign stakes are limited by industry, with ownership caps ranging from 100 per cent in some sectors, 20 per cent– 74 per cent in other sectors, and zero per cent in Agribusiness, Real Estate, and Retailing. Only Foreign Institutional Investors (FIIs) REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228

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approved by the Reserve Bank of India (RBI) are permitted to invest in India’s listed stocks and bonds. The RBI caps individual foreign portfolio holdings at 10 per cent of a firm’s total market capitalisation. Foreign investment in government bonds is limited (currently to US$ 1.76 billion), and total corporate bond ownership by foreign investors is capped (currently at US$ 500 million). In addition to Basel I regulations, the RBI reserves the right to restrict both bank assets and liabilities that originate outside India. This restriction typically restricts foreign exposure to 20 per cent of a bank’s lending portfolio and 15 per cent of a bank’s liabilities. Additionally, the Reserve Bank of India limits the number of banks operating in India and their share to below 10 per cent of India’s total bank assets. India’s foreign exchange regime can be best categorised as a ‘dirty float’. Although the RBI reserves the right to do so, it has never blocked remittances or the repatriation of approved investments, loans, or licensing fees. Indian residents and firms, on the other hand, cannot convert the rupee into foreign currency to acquire assets or lend funds overseas without prior government approval. Thus, while there are still restrictions on cross-border flows of funds, these restrictions are being gradually relaxed. India is not only becoming a larger part of global economic and financial systems, it is also becoming a larger exporter and importer of goods, services, and financial flows. In contrast to the situation in the latter part of the twentieth century, in the twentyfirst century these cross-border flows have now become a very important part of the Indian economy. This increasing globalisation of the Indian economy is reflected not only in its cross-border trade and investment, but also in the impact on India of the 2008 global financial crises.

3.1 Globalisation of the Indian Economy The Indian economy has undergone rapid globalisation since the economic reforms of the early 1990s and these trends towards greater globalisation of the Indian economy have accelerated with continuing economic deregulation. Tariffs for imports have been progressively reduced to the average level of ASEAN countries, REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228



for example, the highest standard tariff rate was reduced from 35 per cent in 2001 to 10 per cent by 2007. While India’s share in world exports of goods and services remains small, having increased from about 1 per cent in 1990 to about 4 per cent in 2007, their domestic role and the overall impact in India have been more significant, where exports make up 23 per cent of Indian GDP (OECD 2007). Indeed, the rapid growth of India’s trade represents a structural change in India’s economy, with the share of external trade in Indian GDP increasing from about 15 per cent in 1990 to about 49 per cent in 2007 (De 2009). The growth of financial integration has been even more rapid. During the 1997–2007 decade, the ratio of total external transactions (gross current account flows plus gross capital account flows) increased by more than 100 per cent from 46.8 per cent of GDP in 1997 to 117.4 per cent of GDP in 2007. Furthermore, corporate borrowing from external sources has also increased significantly. In addition, India is now increasingly the focus of inward FDI from a range of countries. For example, India has overtaken China as the top destination of outward Japanese FDI (Economist 2009). Overall, in 2007 India received capital inflows that amounted to 9 per cent of GDP as against a current account deficit of 1.5 per cent of GDP in 1997 (Subbarao 2009). 3.1.1 Recent Global Crises and India There is much evidence from the 2008 global financial crises that India is well integrated into the global economy. While global and national financial imbalance had been building for many years and major signs of the impending crises were evident by March 2007, the collapse of financial systems globally was marked at its peak by the failure of the investment bank, Lehman Brothers, in September 2008. These crises, fuelled by rising levels of illiquidity and debt, especially in the developed economies, and reflected in massive current account imbalances, real estate, derivatives, and other asset prices rose in huge bubbles in these countries. The financial crises crested when these asset price bubbles started deflating in 2007 and 2008.

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Regardless of their causes, these global crises had major impacts in India demonstrating the Indian economy and its financial systems increasing integration with the global economy and financial systems. For example, global influences have become a major factor driving the Indian equity markets. Along with the fall of foreign investment flows into the Indian stock market, the Indian stock markets declined from their peak in January 2008 of about 21,000 for the Bombay Sensex Index to about 8,500 by October 2008. In 2008, driven most likely by home country liquidity needs, developed country foreign investors had withdrawn, over the same period in 2008, about half of their inflows to India that occurred during 2007. During the same time, the Indian Rupee also declined in value from about ` 38 to about ` 50 per US dollar. Overnight, rates in the Indian money market tripled to the 15–20 per cent range at the height of the global financial crises. Indian economic and export growth rates fell from 9 and 25 per cent per annum in recent years to 6 and 3 per cent per annum respectively in 2008. Fortunately, due to stringent regulations and high capital ratios (at 13 per cent of risk weighted assets), Indian banks were mostly insulated from direct sub-prime and derivatives exposures. Nevertheless, the foreign branches of Indian banks like ICICI Bank and the State Bank of India had some minor mark-to-market writedowns. Unlike China, the export dependence of the Indian economy was a much lower, 20 per cent, aided by significant increases in domestic liquidity by the Reserve Bank of India (about US$ 100 billion or a 10th of the Indian GDP) and a large fiscal stimulus (of about US$ 60 billion) over about six months, India weathered the global financial crises fairly well. The financial markets seem to be well on the way to recovery and in the first nine months of 2009, Indian companies raised US$ 15.5 billion in public equity offerings, an increase of 27 per cent over a comparable year-earlier period.20 However, the domestic impact of these 2008 global crises made it clear how well the Indian economy was now integrated into the global economy. In spite of the global integration of the Indian economy in recent decades, India seems to have survived the recent (2008) global

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financial crises quite well. The crises spread globally through finance and trade, and India managed to avoid extremes in both areas. Countries that relied heavily on exports—like Singapore, Taiwan, and China—suffered when foreign demand collapsed. India’s exports of goods and services never accounted for more than approximately 20 per cent of its economy, compared with approximately 45 per cent for China, and 100 per cent (or more) for some Asian countries. Also, India kept its current account deficit to about 2 to 3 per cent of GDP and India built one of the largest cushions of foreign exchange reserves (about US$ 315 billion). As a result, when the crisis hit, India was able to reassure investors and provide dollars to investors demanding dollars for their rupee assets. These reassured investors kept their money in India. Indeed, at the depth of the global recession, between March 2008 and March 2009, India managed to grow at a rate of 6.7 per cent, well above the rate of most other industrial countries (Subramanian 2009).

3.2 Indian M&A and Globalisation of Indian Business Changes in corporate control, as in M&A, are important indicators of economic health and integration. Such activity reflects the critically important reallocation of capital in an economy to its most productive uses. As discussed below, such activity has been on the rise in India, especially after the economic reforms of the early 1990s. As a result, the national average rate of return to invested capital in India has been much higher than in China and other developing countries. 3.2.1 Indian M&A The modern era of M&A in India dates from 1991. Additionally, Indian M&A activity can usefully be divided into the pre-1991 era and the post-1991 era. In 1991 the Indian government liberalised laws and relaxed constraints that had previously restricted Indian businesses in making domestic or foreign acquisitions. Amendments to the Monopolies and Restrictive Trade Practices Act (MRTP) in 1991 dropped the need for government approval of

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M&As in certain cases. The licensing regime underwent forwardlooking changes to correct what had previously led to the formation of incompetent small industrial entities in sectors that were subject to licensing (Srinivasan 2001). The FDI policy also underwent changes resulting in only a few industries requiring government approval for FDI. Amendments to the Companies Act of 1956 made it possible to transfer shares free of charge, effectively making it more difficult for directors of a company to turn down registration of share transfers. The Depositories Act of 1996 smoothed the progress of the dematerialisation and book entry transfer for securities in a depository. The RBI made it possible for Indian companies to finance their overseas acquisitions by raising capital from domestic banks in 2005. In 2001, the SEBI amended the Takeover Code designed to protect the interest of all stakeholders, to reduce any conflicts or abuses, and to smooth out the orderly progress of M&A activities. The Foreign Exchange Management Act of 1999, Competition Act of 2002, and Special Economic Zones (SEZs) Act of 2005 are among the more recent acts that have also influenced the takeover surge (Meisami and Misra 2008). Consequently, there has been an explosion of mergers and acquisitions (M&As) by Indian firms, both domestic and crossborder. Starting in 1991, four sectors in India have experienced the most detectable M&A trends after deregulation (see Srinivasan 2001). First, the consumer goods sector in which firms desire quick gains of market share and then the banking and financial industry where ‘size’ is an important factor due to higher capital requirements set by the Reserve Bank of India (RBI, 2009), experienced many mergers. Sectors overloaded with many small firms underwent consolidation. Sectors needing high technology such as telecommunication and pharmaceuticals grew dramatically and underwent major merger activity. In addition, after the millennium the relaxation of these regulations led to an explosion of IT, software, and service sector acquisitions. As an example, the cell-phone industry in India is now one of the largest in the world and has been growing at a very rapid rate. Extensive corporate restructuring and M&A in telecoms

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in India has meant that the largest five companies account for 75 per cent of the still exploding market.21 Overall, approximately 23 per cent of domestic takeovers by Indian firms are concentrated in two industries; Chemicals and Allied Products with 15 per cent of the takeovers and Business Services with 8 per cent of takeovers (Accenture 2006). Cross-border M&As for the first seven months of 2006 outnumbered the total number of cross-border M&As in any previous year in Indian history. About 75 per cent of total takeovers in India have been cross-border since 2003. Furthermore, 94 per cent of M&As by Indian companies are expected to be cross-border in the next three years (Grant Thornton 2006). In cross-border takeovers, 45 per cent of takeovers occur in the same two industries as in domestic M&A, with Business Services accounting for 25 per cent of acquisitions and Chemicals and Allied Products accounting for the other 20 per cent of acquisitions. However, since 2000, IT, services, electronics, and high-technology industries accounted for more than 50 per cent of cross-border takeovers. In addition, firms operating in market research, human resources, and forest products have also been active players in the cross-border takeover market (Grant Thornton 2006). As an indication of recent trends, in 2007, there were more outbound M&A deals than inbound M&A deals involving Indian companies, having 240 outbound deals (worth US$ 32.27 billion) and 108 inbound deals (worth US$ 15.61 billion). Outward FDI from India was more than twice the inbound FDI—a remarkable reversal compared to most other developing countries where inbound FDI generally far exceeds any outbound FDI. 3.2.2 Stylised Facts for Indian Outbound FDI Based on analysis of recent trends, there seem to be four main reasons for Indian firms to engage in cross-border acquisitions. These include the need to enter new markets to maintain growth, to gain proximity with global customers, to expand market share and customer bases, and to acquire raw materials and other resources from foreign countries. Much Indian FDI is in other developing countries such as in Africa,22 Middle East, and South-east Asia REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228

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(see Accenture 2006). In recent years, Indian FDI in the developed countries has also increased significantly.23 Indian cross-border M&As have several distinct characteristics compared to those done by firms in the west or from China. Indian acquirers are often smaller in size relative to their counterparts in other countries and usually target smaller firms. Many acquirers do a series of small acquisitions frequently, utilising ‘a string of pearls’ approach’. Since 1995 over 60 per cent of Indian M&As took place in Europe and North America; during the 2000–06 period US firms followed by UK firms were the major target of nine Indian acquirers. More recently, there has been an increasing trend in the size of the firms acquired by Indian companies. For example, from January through November 2006 the total value of Indian cross-border M&As reached the US$ 23 billion level, showing a significant increase compared to the same period in 2005 that was US$ 7.8 billion. Additionally, the portfolio of crossborder M&As has become more diversified relative to the past, with consumer goods and services, energy, pharmaceuticals and healthcare accounting for 66 per cent of cross-border M&As from 1995 to 2005. Many Indian firms participate in cross-border M&As to expand their overall technical capabilities and to update their existing knowledge base. In most cases, the knowledge and technical expertise learned abroad can help the acquirers in improving their productivity in the domestic Indian market as well.24 This has been achieved by Indian firms through two avenues: buying the technology, or acquiring firms who already own that technology. Acquisitions in developed markets have been attractive to Indian firms due to their large customer base, advanced legal system, knowledge foundation, and sophisticated technologies. More importantly, acquisitions often prove to be the only way for Indian companies to begin competing in these markets, due to the high level of existing competition in developed countries. However, to a lesser degree, Indian firms have also acquired firms in less developed countries to help Indian firms gain easier access to a target’s resources. These deals are profitable because of a high demand for foreign investment in some of these economies, and these deals have provided Indian firms with access to raw REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228



materials and other resources. In some cases, Indian firms also engage in cross-border M&As in countries where the demand for their technology has not died out yet. Such acquisitions allow them to diversify the risks rooted in increased competition at home. Cross-border M&A can create excess value for Indian acquirers relative to their competitors, by allowing them to save on labour and production costs. Some Indian firms, especially in the pharmaceutical sector, strive to increase their market share by enhancing their product range or to diversify the portfolio of their products or services. One important reason driving the ‘urge-to-merge’ is the pressure of domestic competition, which has increased greatly in recent years. In any case, many Indian MNCs present tempting acquisition targets and some have been acquired by MNCs from other countries.25 Nevertheless, significant outward FDI from India is still in its early stages and faces a number of challenges. For example, it has been widely contended that many overseas acquisitions by Indian companies have been driven by other than purely commercial reasons. A case in point is the criticism of Tata Motors for being driven by national pride to overpay for its acquisition of the marquee brands, Jaguar and Land Rover. As an example of other difficulties, attempts to acquire MTN, the South Africa based multinational wireless phone company, by Indian companies (first by Reliance Communications and then by Bharti Airtel) have not been successful, with the latest 2009 offer by Bharti Airtel seemingly nixed by the South African government.26 3.2.3 FDI Theories Applied to Indian FDI One of the primary questions in understanding global expansion of firms is how they overcome the limitations of foreignness when they cross borders.27 The reason for cross-border expansion is that the gains from cross-border activity, generally in the form of inexpensive raw materials or not otherwise available technology, are greater than the costs of foreignness. A second explanation is that the form brings certain advantages developed domestically or elsewhere to the new country to overcome the limitations of foreignness. These explanations have been widely explored in the literature but mainly in the context of MNCs from the REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228

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highly industrialised countries. However, it remains to be seen if traditional explanations work for firms from India—a relatively poor and under-developed country but where services are already the largest sector. Do these advantages of traditional MNCs also apply to Indian firms as they expand internationally, especially as the advantages of superior technology, management knowhow, or brand recognition, enjoyed by traditional MNCs from the developed countries may not be readily apparent strengths for Indian MNCs? We consider three theoretical explanations for FDI and examine how they apply to Indian outward FDI. We start with the two main modern theories of FDI and examine how they may apply to Indian FDI, the OLI paradigm (Dunning 1993, 2000) and the PTI Uppsala model (Johanson and Weidersheim-Paul 1975; Johanson and Vahlne 1977). In addition, we also examine a hybrid theory developed especially for FDI from emerging economies (Aggarwal and Agmon 1990). The eclectic OLI paradigm of Dunning (1993, 2000) combines the insights of industrial organisation, international trade, and market imperfection theories to explain the internationalisation process as governed by three general factors: the ownership advantages of the firm (O), the location advantages of the market (L), and the internalisation advantages of conducting transactions within the firm rather than on open markets (I). The ownership advantages include the firm’s asset and knowledge power, such as management know-how, international experience, and ability to develop differentiated products. Traditionally, these were considered to be directly related to size, which helps the firm achieve scale economies, absorb the resource costs of international competition, and enforce contracts while protecting its patents (Buckley and Casson 1976). The location advantages refer to the earnings potential and risks associated with specific markets; the premise is that firms will first seek to enter larger markets with the best growth potential and least risk (Herring 1983). The internalisation advantages relate to the relative costs of integrating the assets and skills of the firm with a foreign counterpart. Shallow modes of entry (such as exports or licensing) tend to minimise these costs, while deeper modes of engagement (such as FDI) involve REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228



higher costs. Agarwal and Ramaswami (1992) describe how the optimal entry mode will usually become a compromise between the firm’s available resources, risk-adjusted expected net returns and desired degree of control. The PTI theory, sometimes referred to as the Uppsala model (Johanson and Weidersheim-Paul 1975; Johanson and Vahlne 1977), differs from the transactions costs approach of the OLI eclectic paradigm by focusing on the process through which firms incrementally engage in foreign markets via a learning process. At the early stages of internationalisation, firms have little knowledge or experience of doing international business or of specific foreign market conditions, implying these firms face a great deal of uncertainty and risk. They respond to this challenge by gradually building their international involvement and learning along the way as they build their knowledge, experience, and commitment to internationalisation. The PTI predicts that firms will initially enter markets that are close to their home base (in terms of geographic, legal, cultural, or other economic measures of distance) because the costs, uncertainties, and risks are lowest there, and that they will further internationalise over time by expanding their geographic spread. While the OLI paradigm focuses on discrete rational decision making and the PTI emphasises organisational learning, both imply that the internationalisation process will likely be a sequential one, a process where firms initially internationalise into geographically, culturally, and psychically close markets at shallow levels of entry mode. As their OLI advantages increase over time, or as they learn and gain experience and confidence according to the PTI, firms will reach further afield at deeper levels of engagement. Aharoni (1971) described this process in life-cycle terms with firms servicing foreign markets with increasing commitment starting with exports leading eventually to overseas manufacturing. Dunning (1993) also outlines five stages of a firm’s internationalisation: from exporting to direct sales, to initial foreign part production, leading over time to new foreign production that deepens and widens the value-added network, and finally to regional or global integration. Finally, the Aggarwal and Agmon (1990) model emphasises the supportive role of the state in explaining the outward FDI from REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228

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developing countries. In this model, the fixed natural comparative advantage of a developing country is modified by government intervention and investment in a non-tradable capital good such as education and/or technology. This, in effect, creates a dynamic long-term government directed comparative advantage for firms based in such a country allowing them to move forward in a product ‘life cycle of firm multinationality’ where shallow modes of foreign entry such as exports by firms are followed by deeper modes such as FDI to progressively develop overseas markets (Aggarwal 1984). The stylised facts on Indian FDI presented earlier in this article seem to be consistent with the contentions of all three theories of FDI. Many Indian firms invested overseas based on their location advantages (L) such as having a low-production cost base in India to support foreign operations of Indian firms (O) serving overseas markets that were initially entered with FDI thus internalising the cost advantage (I). Given that much Indian exports started with neighbouring regional and culturally similar countries before expanding further afield, clearly indicates consistency with the PTI theory and a commitment to learn and gain experience before taking greater risks. Finally, Indian FDI would have been much lower and occurred later, but for the heavy investments made by the Indian government in R&D and world class technical education (e.g., the Indian Institutes of Technology). This moved the comparative advantage available to Indian firms to favour outward FDI earlier than it might have been possible otherwise—FDI from developing countries being a later stage than FDI from the developed countries in the life cycle of multinational firms (Aggarwal and Agmon 1990 and Aggarwal 1984). While the discussion above is useful and even somewhat illuminating, the core question that all theories of FDI must address concerns the mechanisms of how a company overcomes its liability of being foreign when it engages in cross-border expansion. In addressing this issue more specifically for outward FDI from India and perhaps from other smaller and poorer economies, we hope to develop new insights for the unusual MNCs created when companies from relatively less developed economies become MNCs. It is the contention here that Indian and perhaps other REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228



MNCs from the poorer countries may enjoy at least four types of advantages developed in their home markets that they can use overseas to overcome the liability of foreignness. 1. Low Cost Production/Design Bases: Indian companies can and do use the low cost domestic production and design bases as a strength to extend their businesses internationally. Many contend that this is the model that has been used by Indian IT companies to successfully expand globally. In addition, Indian mass production style medical procedures (like open heart operations at Narayana Hrudayalaya Hospital and cataract and eye operations elsewhere in India) designed for low-income Indian consumers are now being taken overseas by India hospitals.28 2. Natural Endowment Driven Technologies: Indian companies may have comparative advantage in certain technologies useful for global expansion, such as non-fading dyes that stand up successfully to bright sunlight, which can best be developed in a country with India’s natural endowments. Other examples of this would be the foreign distribution of raw materials such as Palm Oil and cultural products such as Bollywood movies.29 3. Low Cost Versions of Expensive Products: It has been noted recently that Indian companies are able to create low-cost versions of products developed and marketed for the poorer consumers at the ‘bottom of the pyramid’ which can then be modified slightly and adapted to compete successfully in developed markets. There are many examples of the latter including the ‘Nano’ automobile developed by Tata for the Indian markets and now being exported to Africa, Southeast Asia, and Europe.30 Another example is the inexpensive Little Cool refrigerator with only 20 moving parts (no compressor) and the Mac400 heart monitor developed by GE India. Similarly, Suzlon is now the fourth-largest global windmill company starting with designs developed for the Indian market, and an Indian company now has the largest fleet of electric cars on the road giving it an unequalled edge REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228

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to export electric cars overseas and license its technology to GM for the Chevy ‘Spark’ built for the US market.31 4. Leverage Cultural and Institutional Understanding: Indian MNCs can reduce the costs of foreignness by taking advantage of cultural and institutional affinities—institutional structures in many developing countries, especially in Asia and Africa, are similar to the Indian institutional structure reducing the costs and risks of operating in these countries for Indian parent MNCs. In addition, in many of these countries Indian diasporas are widespread, providing an initially friendly consumer base for India companies (some Indian banks initially expanded overseas mainly to serve overseas Indian populations). Outward Indian FDI has examples of each of these four areas of advantages enjoyed by Indian firms. Firms from other developing countries and from the smaller developed economies also reflect these four advantages in their outward FDI activities. A detailed analysis of this evidence and the nature of MNCs from developing and small developed countries is beyond the scope of this article. The focus of this article has been recent developments in the nature and international integration of the Indian economy.

4. Conclusions This essay is an assessment of the globalisation of the Indian economy and the role played by market development with falling transactions costs and, as a result, the rising levels of domestic and cross-border M&A by Indian firms. These developments started with the reforms of the early 1990s and the availability of new technologies to Indian business. The rate of change facing Indian business is likely to accelerate as these new technologies and economic deregulations form a mutually reinforcing circle of forces. It is shown that both the adoption of new technologies and economic deregulation will reduce transactions costs and make product and financial markets in India more efficient. This increase in market efficiency will then lead to changes in corporate REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228



boundaries among Indian business firms and there is likely to be consolidation within many industries. As most large business houses in India currently are widely diversified, and in many cases vertically integrated, these changes will inevitably lead to a process of significant focusing, restructuring, and perhaps expansion in focused areas to take advantage of scale and network economies. However, these restructuring and consolidation processes are unlikely to be entirely smooth, as many large business groups will be unable to survive in the new, more competitive business environment. India has little experience with large-scale bankruptcies that are more common in countries like the United States. Failures of large firms are likely to be politically and economically disruptive. India will need strong financial markets and effective bankruptcy laws, and a robust commitment to the process of economic deregulation, to survive the significant restructuring of its major businesses that is necessary for it to compete in global markets. Thus, and unfortunately, it seems there is unlikely to be any gains in this area without some pain! Finally, the global integration of the Indian economy is accelerating, not only with declining transactions costs, but also with the resultant rise of many Indian companies’ domestic and crossborder M&A that have been fuelled by continued growth caused by economic deregulation. Many large and some smaller Indian companies are now becoming world class competitors and are extending their global reach. Thus, it is clear that the globalisation of the Indian economy has both macroeconomic and policy roots as well as microeconomic company level drivers. This article makes an important contribution to our understanding of the global role of the Indian economy by relating the internal process of economic deregulation in India with increasing deployment of technology and the resulting economic efficiency; and how these internal processes lead to the increasing pace of external mergers and acquisitions and the globalisation of India business and economy. In the past these internal and external processes have often been viewed separately. This article also contributes by extending our understanding of the nascent phenomenon constituted by the rise of Indian multinational companies. REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228

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Raj Aggarwal is a Frank C. Sullivan Professor of International Business and Finance, College of Business Administration, University of Akron, Akron. E-mail: [email protected]

Notes 1. There is now much evidence that the institutional environment is a significant influence on national economic growth rates (e.g., Olson 1996). Further, as evidenced by the great success of non-resident (overseas) Indians, the institutional environment rather than culture seems to be more important for Indian economic success (Pauly 2000). 2. See, for example, Timmons (3 October 2009) and Leahy (2 October 2009). 3. See, for example, Pokharel and Bhattacharya (2009). 4. See Rieff (2009). 5. See, for example, Aggarwal (2006), Leahy (2 October 2009), and Lambert and Littlefield (2009). 6. See, for example, Polgreen (2009). 7. There are various estimates of the size of the Indian middle class. These estimates range from estimates of about 50–80 million that can afford an automobile to over 300 million that can afford home appliances. 8. This is similar to the situation in the 1970s and 1980s when Japan invested much more capital than the United States for each unit of economic growth. 9. See Merton (2009) and Timmons and Bajaj (2009). 10. The elite Indian Institutes of Technology are now becoming well known for graduating many CEOs of major US corporations and many of Silicon Valley’s leading successes. See, for example, Ghosh (2001). 11. See, for example, Jayaram (2001). 12. See Lamont (16 November 2009). 13. Indian cell phone providers mostly make money providing extra services (such as movie songs, market prices, banking services) and not from talk time. Indeed, there is talk that cell phone talk time may be free soon (Leahy 11 December 2009). 14. See, for example, Kazmin (2009). 15. Some tasks may be performed jointly by units internal and external to a firm. However, this detail is not critical to our analysis here. REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228



16. In a deregulating environment like India, many social institutions that reduce transactions costs may be in a state of flux. Old institutional arrangements and frameworks become obsolete and it takes time to build stable new institutional arrangements with exchange frameworks temporarily exerting an upward pressure on transactions costs. 17. This is starting to take place. See, for example, on restructuring at Tata, Joseph and Khandari (1999). 18. Domestic M&A is already surging in India. See, for example, Merchant (2001). 19. However, the growth of financial markets in India is likely to be impeded by corruption (Aggarwal and Goodell 2009). Fortunately, lately, there are many reports that the media in India is actively reducing corruption by setting up many sting operations and exposing corrupt officials. 20. See Leahy (7 October 2009). 21. As of 2009, these five companies in order of declining share (approximate share) were Bharti Airtel (24 per cent), Reliance (19 per cent), Vodaphone-Essar (19 per cent), Tata (9 per cent), and Aircel (5 per cent). See, Hookway (19 November 2009). 22. According to Financial Times, ‘This is Africa’ (14 September 2009), India invested $ 1.88 billion in greenfield projects in Africa in recent years. Also see, Pal (2009) and Freemantle and Stevens (2009). 23. For example, according to an Ernst and Young and FICCI joint report released in June 2009, Indian companies bought 143 US companies in 2007–08 (94 deals) and 2008–09 (49 deals). 24. One example of this is the use of technology from the Tata acquisition of Daewoo Commercial Vehicles of Korea in 2004 to upgrade Tata ‘Prima’ range of trucks made for the domestic Indian market. 25. A case in point is Ranbaxy Laboratories, an Indian MNC in the pharmaceutical industry, which was acquired on very attractive terms in 2008 by Daichi Sankyo, a Japanese pharmaceutical company. 26. See, for example, Timmons (2 October 2009) and Sharma and Bellman (2009). 27. It should be noted here that the limitations of foreignness in FDI is just a special case of the more general limitations of newness when a firm expands into new markets or technologies. 28. See, Anand (2009). Another example is the global expansion of VNL, an Indian telecom company that developed extremely low cost solar powered telecom base stations initially for use in the poor rural and remote parts of India (‘Global Business: Tech Pioneers’, Time, 28 December 2009, p. 6). Other examples include the exports of the REVIEW OF MARKET INTEGRATION 2(2&3) (2010): 181–228

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initially designed for low income Indian consumers of the Tata Nano automobile and the Mahindra electric truck for urban markets. 29. Another example of this is the multinational nature of Indian IT companies with English-speaking inexpensive workers like Wipro (with operations in 53 countries) which has been outsourcing its Indian projects to its workforce in Egypt (Leahy 12 November 2009). 30. In response to this Tata challenge, Nissan/Renault and Bajaj announced a low-cost competitor to the Nano (Gulati and Relia 2009). 31. See, for example, Bellman (2009) and Bajaj (2009).

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