India: Financial Globalization, Liberal Norms, and the Ambiguities of Democracy

Financial globalization is commonly seen to be detrimental to democracy in developing
countries. Writing for an international committee of 21 social scientists, Adam Przeworski asserts
that “modernization by internationalization” involves “at least a partial surrender of national
sovereignty in the political, economic and cultural realms” which weakens nascent democratic
institutions. Tony Porter argues that financial globalization enables unaccountable international
authorities to usurp control over key decisions about financial regimes from domestic authorities.
Leslie Elliott Armijo expresses the concern that the shift from public to private capital flows that has
accompanied globalization in the last fifteen years may oblige states in developing countries to
implement neoliberal policies regardless of their efficacy. Armijo contends that financial
globalization will skew resources to disproportionately strengthen the political power of big
business. She adds that the more liquid forms of international investment can destabilize democratic
This essay raises questions about these pessimistic views concerning the impact of financial
globalization on democracy. Arguments that financial globalization curtails democracy tend to
extrapolate from an obscure baseline founded on unexamined assumptions about the nature of
financial regimes prior to globalization. It is misleading to draw conclusions about the impact of
financial globalization on democracy without first considering the relationship between the financial
sector and democracy prior to globalization. The case of India’s stock exchanges demonstrates that
prior to globalization, capital markets can have detrimental consequences for democracy.
The assumption that state sovereignty and democracy are positively related merits further
scrutiny. International efforts to advance human rights in authoritarian regimes offer instances
where the reduction of state sovereignty can promote democracy. The relationship between financial
globalization and democracy is more complex than pessimists allow because while financial
globalization has limited state sovereignty, it also has spread liberal norms which bolster democratic
institutions. The experience of India demonstrates that even in countries with liberal democratic
political institutions, the weakness of liberal economic norms — especially the equitable application
of laws to regulate market actors — may facilitate the efforts of a privileged few to manipulate
markets for their personal advantage. This manipulation often serves as a channel for corruption
that has a corrosive impact on a country’s democracy. By promoting the spread of liberal norms,
globalization has provided greater protection for the rights of investors. In the process, it has
diminished the opportunities for corruption. This contention does not dispute that control over
financial policies is to some extent usurped by international investors and foreign authorities who
promote financial reform largely for their self-interest. Instead, it observes that international
investors’ pursuit of predictability and calculability has promoted the spread of liberal norms which
have restricted the arbitrary exercise of state power and promoted equity of procedure. These
developments have had a positive, albeit limited, impact on Indian democracy. To fully appreciate
the impact of financial globalization on democracy we must account for the balance between the
democratic deficit resulting from diminished control over fiscal and monetary policy and the
enhancement of democracy deriving from the spread of liberal norms.
Finally, the essay will investigate the argument that financial globalization produces
inequalities that will inevitably curtail democracy. Financial globalization produces winners and
losers. These are not only the wealthy and poor or corporations large and small. They are also
localities that reap the benefits of globalization by tapping into international capital flows and
production networks and those that do not. When growing regional disparities increase in
multinational states such as India, they may be more threatening to democratic institutions than
growing disparities between wealthy and poor individuals. At the minimum, coping with regional
disparities is likely to be an issue that confronts the world’s larger and more heterogeneous
democracies. The exacerbation of disparities between individuals and corporations, however
normatively undesirable, is less likely to undermine democratic institutions. This contention is
founded on Huber, Rueschemeyer, and Stephen’s distinction between formal, participatory, and
social democracy. While vertical inequalities are detrimental to participatory and social democracy,
they are quite compatible with formal democracy. The case of India suggests that the disparities
resulting from financial globalization may not threaten the country’s democratic institutions even
while they erode democracy’s participatory and social dimensions. Indeed, the era of financial
globalization has been an age when democratic institutions have spread across the globe at the same
time that economic inequalities have grown.
The essay’s organization is as follows. I begin by examining the economic dimensions of
financial globalization in India. Next, I describe the operation of India’s stock exchanges prior to
reforms. This discussion will provide a baseline necessary for understanding the impact of financial
globalization on India’s democracy. Then I investigate the impact of financial globalization on the
operation of India’s stock exchanges. In particular, I will examine its role in promoting the reform
of India’s stock exchanges. Finally, I demonstrate how financial globalization has created a new
economic geography which more than any other development may cause tension in India’s

The Economic Dimensions of Financial Globalization in India

Though India began to take advantage of financial globalization by securing commercial
loans and accessing the savings of Indians abroad in the 1980s, the country made serious efforts to
attract foreign direct and portfolio investment only after it initiated economic reforms in the wake
of the 1991 balance of payments crisis. Total foreign investment, increased from an annual average
of less than $100 million a year in the 1980s to $6.4 billion in 1996-97. Foreign direct investment
(FDI) grew from $158 million in 1991-92 to $2.6 billion in 1996-97. (See table 1) The most recent
press reports put it at $3.5 billion in 1997-98. Despite this increase, FDI in India remains
considerably below that of many developing countries. In 1996, India, a country with 19 percent of
the population of all developing countries, received only 2.9 percent of all FDI to developing
The increase in FDI in India occurred in response to reforms designed to make the investment
environment more attractive. Prior to 1991, FDI was limited to 40 percent of joint ventures, except
in a few high-tech areas, and approval was time consuming and arbitrary. In 1991, the Government
of India permitted automatic approval for joint ventures with up to 51 percent equity in 35 industries.
It also established the Foreign Investment Promotion Board to provide single-window approval other
projects. When the United Front government came to power in May 1996, it announced the goal of
increasing India’s FDI to $10 billion a year by the year 2000. In December 1996, new guidelines
were issued extending automatic approval for ventures with up to 51 percent foreign equity in 13
industries and adding automatic approval for foreign equity up to 74 percent in nine industries
predominantly in infrastructure and of not more than 50 percent in three mining industries. In
1990- 1991- 1992- 1993- 1994- 1995- 1996-
91 92 93 94 95 96 97

I. Direct Investment 165 150 341 620 1,314 1,981 2,590

II. Portfolio Investment 0 8 92 3,493 3,581 2,096 3,850

A. Foreign 0 0 1 1,665 1,503 1,892 2,390

B. Euro-issues/GDR’s 0 0 86 1,463 1,839 204 1,460

C. Others* 0 8 5 365 239 — —

III. TOTAL (I+II) 200 158 433 4,113 4,895 4,077 6,440
*Includes NRI portfolio investments, offshore funds, and others

Sources: Data for 1990-91 to 1995-96 from World Bank, India: Country Economic Memorandum.
Washington, DC. World Bank, 1996, p. 7. Data for 1996-97 from Ministry of Finance press release,
May 1997 as cited in Indira Rajaraman, “A Profile of Economic Reform in India” (National Institute
of Public Finance and Policy, New Delhi, June 1997). limited circumstances, the new regulations permit 100 percent foreign equity. The criteria for FIPB
were codified and published for areas without automatic approval, and a Foreign Investment
Promotion Council was created to encourage FDI.
Portfolio investment in Indian firms was allowed only in September 1992. It has since grown
to an annual net total of $3.8 billion with $2.39 billion coming from the purchases of Foreign
Institutional Investors (FII’s) on India’s capital markets, and $1.46 billion acquired through Global
Depository Receipts (GDR’s). The 1992 reforms limited foreign portfolio investment to FII
purchases of not more than 24 percent equity in any firm with no single FII owning more than 5
percent. In 1996, these limits were increased to a total ceiling of 30 percent with a 10 percent
maximum on any single FII. Regulation of GDRs was liberalized in June 1996 expanding the
eligibility for firms to enter foreign markets and relaxing the restrictions on the number of issues that
a company can float and the end uses for such funds. In November 1996, India allowed FII’s to form
“wholly debt-based” funds, replacing the 30 percent limit that FII funds could hold in private debt.
In January 1997, India opened its $36 billion government securities market to FII’s, taking the first
step towards enabling the government to sell its debt in overseas markets. By the end of March
1997, there were 427 FII’s operating in India.
The new opportunities to attract foreign investment and the proliferation of FII’s on India’s
capital markets were catalysts for changes that transformed India’s capital market institutions. To
comprehend the dynamics of this transformation, we must first understand the nature of India’s
capital market institutions and key actors prior to the reforms. Only then can we understand the
interplay between actors and institutions that shaped the trajectory of change in India’s capital market
and ultimately in the Indian state.

Legitimacy, Dependence, and the Politics
of Reforming India’s Stock Exchanges

It is sometimes assumed that having long established capital markets would facilitate efforts
to attract foreign investment and reform the economy to promote greater efficiency. The case of
India suggests that the institutional legacy of capital markets can impede as well as facilitate reforms.
During the long history of India’s stock exchanges social institutions and norms were constructed that
impeded market efficiency. These institutions and norms also were barriers to attracting foreign
Founded in 1875, the Bombay Stock Exchange (BSE) is the oldest exchange in Asia. Until
1995, it was by far the largest of India’s 22 exchanges. The BSE lists almost 4500 of India’s 7000
listed companies. Firms listed on the BSE account for more than 80 percent of the $139 billion
capitalization of India’s stock exchanges. Some 650 of India’s 2200 brokers work at the BSE. Many
of them have traditionally come from a common ethnic (Gujarati) community, and in many cases,
their family members have worked as brokers on the BSE for generations.
In the past, these brokers formed an exclusive club which exploited the Bombay and India’s
other stock exchanges for their personal advantage. Indeed, their ethic was similar to that depicted
in Max Weber’s concept of “ancient capitalism.” Rather than increasing their profits by maximizing
the volume of transactions that they conducted, the traders attempted to maximize their returns on
individual transactions, even if it meant rigging institutions to the disadvantage of investors. As
a group, these brokers brazenly manipulated the investments of the public to enhance their private
wealth, and they resisted modernizing the archaic technology of the stock exchange because they
feared that changes would transform their traditional business practices and curtail their
opportunities to exploit the system. Furthermore, modernizing India’s stock exchanges received low
priority in the institution-building plans of India’s Nehruvian state where it was envisioned that it was
preferable to channel investment through public sector banks or the state itself. India’s stock
exchanges epitomized a classic rent-seeking equilibrium in which concentrated and powerful vested
interests subjected diffuse public interests to their exploitation. If ever economic development
confronted a collection action problem it was in the reform of India’s stock markets.
The problems of India’s stock exchanges have long been well known. They were outlined
in great detail in a comprehensive review conducted by the High Powered Committee on Stock
Exchange Reforms chaired by G.S. Patel, former Chairman of the Unit Trust of India and whose
membership reads like a list of superstars of the Indian financial world. The government sponsored
committee issued a remarkable indictment,
…The security business in the country has tended to be in the hands of a few families
of stockbrokers whose actions are primarily governed by the need to protect their
own interests and bereft of the interests of the investing public and even obstruct the
attempts of the Government aimed at making the Stock Exchanges efficient
instruments for mobilising savings of the community for national development….

The stock brokers were criticized for being “unprofessional and poorly skilled. Hardly five
percent are properly trained and equipped.” They also were charged with creating inordinate delays
and array of malpractices including insider trading, concealing speculative trading on their own
accounts from stock exchange authorities, colluding with promoters to manipulate premia on new
issues by buying up shares to attract investors and then selling the shares for a profit leaving
unsuspecting investors with losses, and rigging stock market quotations to illegally enhance profits
from options trading.
India’s archaic settlement system was at the root of many of the problems that plagued its
stock exchanges in the mid-1990’s. Some 80 percent all transactions for individual investors on
India’s stock exchanges were initiated through the more than 100,000 sub-brokers in India. Brokers
employed networks of sub-brokers as an economic means of reaching India’s millions of small
investors. Utilization of sub-brokers was especially convenient since the sub-brokers are not subject
to legal regulation, and brokers were not legally liable for their sub-brokers’ actions. Sub-brokers
acted as a blinder on transparency since they usually do not disclose the broker’s costs for executing
the transaction. Given the long delays involved in completing a transactions (see below), the failure
of disclosure provides a window of opportunity for manipulation.
The great paper chase necessary to complete transactions on India’s stock exchanges began
with the requirement that each share certificate along with a transfer deed must be signed by the
seller before a transaction can be completed. The most frequently traded shares legally should have
been delivered within a fourteen day accounting period. However, many exchanges allow settlement
of accounts within two periods or 28 days, claiming that this allows time to receive shares and
payments from clients in remote locations and process the necessary paperwork.
Large investors such as Foreign Institutional Investors (FII’s) faced an additional problem.
The size of share certificate denominations is small, usually in lots of 10 or 50 shares with 100 shares
being the traditional maximum. This means that FIIs frequently ended up acquiring thousands of
share certificates. The FII’s appointed banks as custodians responsible for completing settlements
and registering their purchases. During an early peak period of activity from November 1993 to
January 1994, FII purchases overwhelmed their custodians with a sea of paper creating a major
Changes in ownership must be registered by sending all share certificates and transfer deeds
to registrars appointed by the company whose shares are being traded. Indian law stipulates that
companies should register transfers of shares within 60 days. The present average for FII’s is nearly
four and one-half months, and it can take much longer. If registrars discover problems with a seller’s
signatures on any of the transfer deeds, as they do with regularity, they return the shares and deeds
to the owners or share custodians who in turn must contact the seller’s broker to resolve the problem.
But these brokers have little incentive to redress the situation, and their inattentiveness often
produced exasperating delays. According to one estimate, 15-20 percent of all FII transactions are
in trouble at any single time.
Brokers, issuing companies, and sellers each maintained a vested interest in the India’s
Byzantine system. Brokers used the periods between sales and settlement to speculate with their
clients’ money. Issuing companies, who legally can refuse to recognize the transfer of share
ownership and indefinitely delay transfers through their registrars, used their control over the
registration process to keep shares out of circulation and minimize sales that might depress the price
of their stock. Companies also used their control over the registration process to prevent hostile
takeovers. Sellers sometimes intentionally mis-signed their names as a hedge in case they later want
to try to void transactions.
India’s stock exchanges were ineffectual in regulating the markets. According to the Patel
commission, the governing bodies of the exchanges “allow[ed] crisis situations to develop in the
Stock Exchanges by neglecting to take timely action to curb excessive speculation.” The majority
of India’s stock exchanges remained closed 40 to 50 percent of the a year, and even when they were
open they operated for only three hours a day. The board of directors of the stock exchanges were
dominated by stockbrokers whose vested interest in maintaining the status quo discouraged them
from modernizing the operations of the markets. They frequently have failed to take disciplinary
actions against the unethical actions of their fellow brokers. Under their management, the stock
exchanges were “generally regarded to be relatively unsafe for the average class of investors.”
How did public interests triumph over this rent-seeking equilibrium? It took more than two
years after the release of the Patel Committee’s report for the government to take action, and even
then, its action was largely symbolic. In April 1988, it established the Securities and Exchange
Board of India (SEBI) to regulate the country’s exchanges. However, SEBI could do little until it
was given a statutory powers and legal sanctions.
The creation of SEBI appears to have been little more than a ritual enactment of a globally
legitimated policy prescription. The best way to make sense of the establishment of SEBI in 1988
is as an attempt to enhance the legitimacy of India’s capital market institutions in the eyes of the
domestic and global public. It is otherwise difficult to explain why SEBI was established without
the authority of legal sanctions and therefore was ineffectual in resolving the notorious problems of
India’s capital markets. In 1989, shortly after it was founded, SEBI joined the Montreal-based
International Organization of Securities Commissions (IOSCO), the institution which served as the
center of the emerging regime for international securities markets during the 1980s and 1990s. It
is likely that the activities of IOSCO’s Development Committee, especially reports like its paper on
“Market Automation and its Implications for Regulatory Activities” were of considerable interest
to Indian regulators. India’s active interest in IOSCO’s activities is evidenced by its election to
IOSCO’s executive committee in 1991. More recently, India has committed to raising its
requirements for the capital of security market intermediaries in order to meet the capital adequacy
norms prescribed by IOSCO. India’s interest in learning from foreign market institutions is also
manifest by its agreement with U.S.A.I.D. to sponsor the “Financial Institutions Reform and
Expansion Project” to modernize its stock exchanges.
SEBI was a policy solution chasing a policy problem. By creating a sense of urgency and
thrusting new actors into positions of policy-making authority, the balance of payments crisis of
1991 created a window of opportunity for empowering SEBI and taking other measures to resolve
the problems of India’s capital markets. Only after the balance of payments crisis of 1991 was SEBI
given statutory authority through the SEBI Act (1992). The balance of payments crisis and pressures
from international financial institutions stressed the need for fiscal austerity. As the limits of state
resources became more evident, reform of the country’s stock exchanges to make them a more viable
source of finance for economic development became more desirable, at least in the eyes of economic
policy-makers. India’s economic crisis thrust Manmohan Singh into power as India’s Finance
Minister in order to avail the government of this Oxford trained economist’s technical expertise. It
was Manmohan Singh who was primarily responsible for giving SEBI legal sanction and providing
the support within the government that was necessary for initiating stock exchange reforms.
In giving SEBI legal authority to regulate India’s stock markets, the Government of India
repealed the Capital Issues (Control) Act of 1947 and abolished the Controller of Capital Issues
(CCI). This reform was a major step moving from direct government control to procedural
regulation of the capital market. Prior to the reform, all firms wishing to enter India’s primary market
had to secure the approval of the CCI, and it was the CCI not the market that set the price and
premium for each issue. Under SEBI’s regulation, companies were now free to enter the capital
market and set their own prices after meeting SEBI’s norms for their offer documents.
The SEBI Act of 1992 and the Security Laws (Amendment) passed on March 25, 1995
authorized SEBI to register and regulate all security market intermediaries including custodians,
depositories, venture capital funds FII’s and credit rating agencies. In an effort to better protect
investors SEBI strengthened the standards of disclosure on primary markets, introduced prudential
norms for issues and intermediaries, and streamlined issue procedures. The 1995 amendment to the
SEBI Act for the first time enabled SEBI to file suits against violators of its regulations without prior
approval of the central government. It provided SEBI with subpoena powers for records, documents,
accounts, and personal testimony, and it authorized SEBI to levy fines for violations of its
regulations. The Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair
Trade Practices relating to securities markets) Regulations issued in 1995, defined fraudulent and
unfair trade practices and authorized SEBI to take action against these practices.
SEBI’s exercise of its regulatory powers embroiled it in a protracted feud with India’s stock
brokers. The conflict between SEBI and members of the BSE was especially vehement. The BSE
brokers went on strike for four weeks in the spring of 1992 in an effort to resist rules requiring them
to register with SEBI. They also vehemently protested SEBI’s December 13, 1993 ban on badla or
carry forward trading. Their efforts secured the transfer of SEBI’s chairman, and ultimately obliged
SEBI to reintroduce a modified form of carry forward trading in December 1995.
Ultimately, SEBI has succeeded in asserting its authority over the BSE and India’s other
exchanges. It reconstituted the governing boards of the BSE and the other exchanges. It issued rules
requiring that board members must be equally balanced between elected representatives of
stockbrokers and its own nominees. SEBI has issued rules for making the client-broker relationship
more transparent, in the process, regulating sub-brokers, segregating client and broker accounts, and
introducing capital adequacy norms for brokers. SEBI directed all stock exchanges to set up clearing
houses or clearing corporations and to provide trade guarantees. Under SEBI’s guidance, all the
exchanges set up surveillance departments, and have begun to coordinate their investigations with
Stock markets are supposed to promote economic efficiency by enabling the takeover of
inefficiently managed firms. In 1994, SEBI issued regulations intended to make the takeover process
more transparent and protect minority shareholder interests. In January 1997, SEBI published a
revised code that facilitated takeovers by, among other things, eliminating the requirement that a
bidder’s price be approved by regulators. The new code also offers better protection of the rights of
minority shareholders. Any investor who takes a stake of 10% in a company must then make an
offer for a further 20%; after that any substantial increase has to be by an open offer to all
shareholders. Finally, the new code is designed to encourage changes in the management of “sick”
companies; saving jobs and protecting the interests of shareholders and creditors. Previously,
companies whose entire net worth had been eroded were referred to the Bureau of Industrial and
Financial Reconstruction which after completing lengthy hearings would determine whether to close
down, restructure, or sell a company. Under the new takeover code, financial institutions can invite
takeover bids after companies have lost only 50 percent of their net worth. Finally, in February
1998, the Government of India took another measure to promote corporate take-overs by announcing
that financial institutions could lend money to fund takeovers.
By the spring of 1998, these reforms were already having a dramatic impact as a wave of
takeovers swept across India’s corporate sector. Some of these takeovers involved the sale of Indian
equity to multinational corporations such as the sale of Lakme to Hindustan Lever, Merind to
Wockhardt and SRF Finance to GE Capital. Others such as the sale of Dabur to Ranbaxy involved
takeovers by Indian firms. For the first time, India’s capital market has a wave of hostile takeovers
including India Cement’s take over of Raasi and Sterlite’s attempt to purchase of Indal. These
takeovers may lead to greater efficiency as successful firms takeover inefficient ones, and
overdiversified Indian business houses sell off peripheral operations in order to concentrate on core
competencies. However, in order to ensure that the takeovers lead to greater efficiency rather than
increasing multinational domination of the Indian economy the government will need to implement
new reforms especially competition policies to ensure minimum levels of competition and possibly
tax incentives to motivate sellers to reinvest their revenues to promote productivity.
The government’s initiative to create competition among India’s stock markets has been even
more effective in promoting reform than have the efforts of its regulators. Just as the founding of
NASDAQ in the United States created pressure for reform of the New York Stock Exchange, India’s
National Stock Exchange (NSE) has pressured the BSE to reform. The NSE provides scripless, on-line trading via a satellite based network which by June 1997 linked brokers in 145 Indian cities.
It opened for trading in equities in October 1994, and before the end of 1995 its volume outstripped
that of the BSE.
The NSE is designed to be more investor-friendly than the BSE. NSE members must rectify
bad deliveries within 48 hours. Bad and short deliveries that are not rectified are sold at an auction
in which the erring broker is prohibited from participation. Deliveries are then completed with only
a few days delay. Brokers on the NSE receive penalty points for defaults on deliveries and
payments. They are fined when they accumulate more than 51 penalty points, and they are
suspended from trading for five days when their penalty points reach 100. The NSE has created an
Investor Compensation Fund (IFC) financed by .001 percent levy against the monthly turnover of
member brokers and 2 percent of the annual fees collected from all listed companies. The ICF is
designed to reimburse any loss suffered by investors because of a member’s default.
Competition between the NSE and BSE has provided strong impetus for reform of the BSE.
The NSE was incorporated on November 1992 only after the BSE refused to implement SEBI’s
recommendations to: admit new brokers, register current brokers with SEBI, and accept new capital
adequacy norms. In contrast to the BSE which is owned and managed by its broker members, the
NSE is owned by state financial institutions and run by professional managers. Brokers pay a fee
for using the NSE’s services rather than buying seats on the exchange as they must for the BSE.
While the NSE was set up with an electronic order-matching mechanism that matches buy and sell
orders automatically, the BSE introduced the Bombay On Line Trading (BOLT) system only late in
1995 at roughly the same time that the NSE surpassed its daily turnover. The BOLT system still
requires brokers and jobbers to quote prices. Competition with the NSE also encouraged the BSE’s
decision to reduce its maximum settlement period from two to one week. Competitive pressures for
reform are more intense than ever. By June 1996 average daily turnover on the NSE increased to
$426 million while average turnover on the BSE totaled just $168 million.
Many of the problems of India’s stock exchanges could be alleviated through the creation of
share depositories or clearing house systems that centralize share collection and use a computerized
system of book entries to replace physical share transactions. Foreign financial institutions, in
particular, have clamored for the establishment of a depository. In October 1996, the NSE joined
with the Industrial Development Bank of India and the Unit Trust of India to inaugurate the country’s
first depository, National Securities Depository Ltd. In April 1997, the NSDL received boost when
it secured a favorable ruling from the U.S. Securities and Exchange Commission permitting U.S.
institutions to participate in the NSDL even though it did not meet its criterion for $200 million net
worth. By March 1998, 180 companies had agreed to join the NSDL accounting for 40 percent of
the India’s market capitalization. One hundred and fifty one companies had issued dematerialized
shares, and the shares of 131 of these companies were actively traded.

The Reforms, Corporate Culture and Corruption
In a provocative essay, Phillippe Platteau has argued that imposing markets in societies
whose cultures are not supportive of market operations may create more problems than it solves.
In Platteau’s view, India remains a society where family and caste relationships take primacy over
the liberal norms. As a consequence, many will exploit market opportunities to favor personalistic
ties and take advantage of outsiders even when their actions are detrimental to the long-term health
of the market. The operations of the BSE prior to the reforms seems to support Platteau’s
observation. However, analysis of recent changes in India’s capital market demonstrates that
Platteau underestimates the impact of globalization and reform of domestic institutions on the culture
of corporate India.
Most Indian firms are family owned and managed. Family businesses account for 70% of the
total sales and net profits of the biggest 250 private sector companies. The controlling interests of
these families is only a small share of a company’s total equity, typically less than 25 percent.
Public sector financial institutions control roughly 40 percent of large companies, with the rest
owned by small investors. Many business families take advantage of pliant financial institutions and
powerless small shareholders to conduct business off the books, have their companies pick up the
tab for personal expenses, etc. According to one estimate, Indian business families have deposited
an $100 billion in Swiss banks. Some Indian firms exploit the stock exchange by manipulating
their share prices and engaging in insider trading. Scandals involving Reliance Industries, India’s
largest private sector company, and CRB, a financial company are indicative of much broader
India’s regulatory agencies are understaffed and possess inadequate resources to prevent
manipulation of the stock exchanges. SEBI for instance, has a total staff of only 300 — only 12 of
which are lawyers — compared to the Securities and Exchange Commission in the United States
which has a staff of 3000 of which 1800 are lawyers. Furthermore, SEBI itself may not be entirely
immune to the blandishments of corruption as suggested by the Central Bureau of Investigation’s
probe into SEBI executive director Pratip Kar links with the CRB group. Nevertheless, excessive
preoccupation with the pre-reform culture of India’s brokers, financial companies and corporations
and the patently inadequate resources of SEBI neglects profound changes that are occurring.
Despite these conditions, the culture and practice of India’s capital markets and corporations
are being altered by the institutional transformation that in large measure has been driven by
diffusion of global norms. India’s stock brokers are undergoing a wrenching shake out. During the
fall of 1996, the President of the Bombay stock exchange, M.G. Damani predicted that one-quarter
of the 641 members of the exchange will disappear in the following 12 months. Others predict only
100 brokerages will survive. From its founding in 1875 until 1992 when the government allowed
domestic mutual fund concerns to set up brokerages, only individuals or sole proprietorships could
be brokers on India’s stock exchanges. The arrival of FII’s, who are the most active traders of India’s
blue chips, and the establishment of the NSE have shifted business to the larger, more professional
brokerages with the capital to fund research departments and keep up with changing technology.
The reforms have induced India’s financial institutions to become more active shareholders.
With the bear stock market of recent years, growing competition, and low spreads, selling shares to
takeover bidders has become increasingly attractive. The Andhra Pradesh State Industrial
Development Corporation’s sale of its 345,766 shares of Indal to Sterlite in March 1998, was one
of the first times that an Indian financial institution acted with a depoliticized, commercial rationale
to facilitate a hostile takeover. Increasingly, Indian financial institutions are under pressure to
monitor their equity portfolios and evaluate them along commercial lines. This will inevitably
pressure the management of Indian corporations to improve performance.
Pervasive change is occurring in the culture of corporate India. The greater availability of
capital as a result of the influx of foreign capital, the increased activism of FII’s and Indian financial
institutions, and the changes in the institutional context of India’s corporate governance are each
obliging Indian corporations to make their governance more transparent. The have placed corporate
India under pressure to meet higher standards of performance and be more responsive to the interests
of shareholders, foreign and domestic alike. Rather than inefficiently diversifying in response to
the old industrial licensing system, India’s business houses are selling peripheral operations to
concentrate on core competencies. Another manifestation of corporate India’s concern to improve
governance is the Confederation of Indian Industries effort to draft a code of corporate governance
for Indian business.
By curtailing the exploitation of privilege and implementing institutional reforms that subject
brokers to proper legal procedures, the reform of India’s capital market, has made a limited
contribution to the more equitable operation of India’s economy. It also has strengthened Indian
democracy. Corruption in India’s capital markets inevitably spills over to India’s state institutions.
Perhaps the best example of this is the two billion dollar scam uncovered in April of 1992. The
scam implicated not only the flamboyant broker Harshad “the Big Bull” Mehta, but also 22 public
sector enterprises — which illegally diverted funds worth billions of dollars to Mehta, the four largest
foreign banks in India, a member of the Planning Commission, and top officials in the Reserve Bank
of India (India’s central bank), including the Governor — who met with Mehta and listened to his
request for special treatment. The Joint Parliamentary Committee convened to investigate the
scandal concluded that the scam’s irregularities were:
“manifestations of … chronic disorder since they involve not only the Banks but also
the stock market, financial institutions, PSU [public sector units], the central bank
of the country, and even the Ministry of Finance, other economic ministries in
varying degrees. The most unfortunate aspect has been the emergence of a culture
of non-accountability which permeated all sections of the Government and Banking
system over the years.”

That isn’t all. In July 1993, Harshad Mehta claimed that he made an illegal political contribution
to Prime P.V. Minister Narasimha Rao worth $360,000. The charge received widespread press
coverage and remarkable public credulity despite the absence of corroborating evidence. Mehta’s
charge incited opposition parties to call for a vote of confidence in Parliament on July 26, 1993.
Rao’s controversial efforts to muster a parliamentary majority for his minority government ultimately
led to his indictment along with nineteen other politicians and bureaucrats for charges that they had
bribed ten opposition members in order to win the vote. Preventing future Harshad Mehta scams
would make a substantial contribution to curbing the corruption of India’s political institutions and
enhancing their legitimacy.

India’s Growing Access to International Capital Markets

Leslie Armijo argues that opening up international capital markets to the corporations of
developing countries will favor large corporations with good reputations. Indeed, the most
successful of India’s GDR issues read like a “Who’s Who” of Indian business. Reliance Industries,
the flagship of Indian corporations, has raised the largest amount, $450 million. Other corporate
stars raising large sums of money include Grasim with $190 million, Larson and Torboro with $150,
and Ashok Leyland with $138 million. The benefits of foreign capital issues have not been confined
to the private sector as a number of large public sector corporations also have taken advantage of the
opportunities. Through 1995, about half of the GDR and FCCB issues have come from firms ranked
among the India’s top twenty according to sales with much of the balance coming from smaller but
fast-growing companies in high-technology areas such as pharmaceuticals.
It may be true that the advantages reaped from accessing international capital markets by big
business in India enhances their political strength and makes them less politically accountable, but
most democracies coexist with powerful corporations, even if the disparities in political power that
they exploit diminish the equity of the political process. In India, the real danger from foreign capital
flows and greater linkage with the global market comes from the geographical disparities that are
likely to result.

Globalization and the New Economic Geography

Democracies can coexist with much higher levels of foreign investment than India has seen
in the recent past or that it is likely to see in the foreseeable future. After all, advanced industrial
countries in Western Europe have the highest levels of foreign capital flows and they are among the
world’s most stable democracies. However, India differs from western European countries in its size
and social heterogeneity. India has 13 languages with more than 20 million speakers, and many
other languages serving as the mother-tongues for a smaller number of people. Indian states are
organized on linguistic lines. Each has its own distinctive culture and history. Indeed, many Indian
states are larger in population and territory than European nation-states. Seven Indian states have
more than 55 million inhabitants while from Portugal to Russia only six European states have more
than 55 million people. Three Indian states have more territory than Italy, and a total of thirteen have
more area than Austria. India is much more heterogeneous than any Western European state. In fact,
in terms of social diversity it is more comparable to Europe as a whole. In Europe, uneven
development and international capital flows have been an impediment to economic integration. In
India, international capital flows may exacerbate uneven development and put pressures on the
country’s political integration. Below, I focus on two changes that are likely to increase regional
economic disparities and exacerbate tensions between Indian states.

Competition among states and inter-regional rivalry
What do Jyoti Basu, a member of the Communist Party of India (Marxist); Manohar Joshi,
a leader of the Hindu chauvinist Shiv Sena, and Lalu Prasad Yadav, a leader of the caste-based
Janata Dal, all have in common? Each visited the United States during 1995 as heads of Indian state
governments attempting to promote foreign investment in their states. As fiscal pressures
increasingly limit the financial largesse of the central government, state governments have initiated
measures to curb wasteful expenditures and enhance their revenue base by attracting investment.
As state and local governments become more involved in attracting investment, creating local
infrastructure, and articulating industrial policy, economic liberalization has relaxed central
government regulation of foreign investment and eliminated its licensing of industrial investment
and production. The relative importance of state and local government policy in promoting
industrial development has increased. A clear manifestation of this change was the Enron
controversy in which the state government of Maharashtra negotiated, renounced, and then
renegotiated the largest foreign investment project in the history of the country while India’s central
government was relegated to the sidelines.
In contrast to the conventional wisdom that the states lag behind the central government,
there are already indications that state governments are being transformed into engines of economic
reform. For instance, while the central government is struggling to find ways to close down
inefficient public sector enterprises (PSE’s), the government of Uttar Pradesh has closed down 13
of its 50 PSE’s, and it leased several of its 24 spinning mills to the private sector. Gujarat,
Maharashtra, and Punjab have been leaders in contracting with the private sector for the provision
of an array of municipal services. Maharashtra, Rajasthan and Punjab have privatized collection of
octroi, and Rajasthan has announced that it will privatize power distribution in selected districts.
Attracting investment also has become a vital part of building local revenue bases and
creating jobs. Virtually, all states have formed industrial development corporations to encourage
domestic and foreign investment. Private investors now take advantage of the eagerness of state
governments to attract investment to pressure them to arrange more favorable terms. For example,
Ford was able to create a bidding war between the governments of Maharashtra and Tamil Nadu
each of which were attempting to attract the automaker’s investment to construct a plant for building
the Fiesta. The upside of these competitive pressures is that it may drive India’s states to implement
creative programs to promote local-level development. The down-side of the growing competition
among states is two-fold. First, it creates a “competitive concessionalism” whose tax concessions
and subsidies are detrimental to fiscal and developmental efforts. Second, the competition will
produce winners and losers. Those states with more dynamic governments, good infrastructure,
strategic location, and well established industrial bases have been much more successful in attracting
investment than have less dynamic states. The disparities are manifest in the contrast between the
success in attracting FDI by Delhi , Maharashtra, and Gujarat and the failure of Bihar, Uttar Pradesh
and Rajasthan. The former attracted 39 percent of all India’s FDI to just 15 percent of the country’s
population. The latter states attracted only 3.5 percent India’s FDI to more than 32 percent of its
population. (See Table II)

“Commodity chains” and growing regional disparities
Changing patterns of global production also may exacerbate regional tensions. Since the
1970s, a new form of international business organization has evolved. Economic enterprise is
increasingly organized into international networks of firms designed to minimize costs and maximize
flexibility and innovation. These “commodity chains,” as Gary Gereffi has called them, reorganize
economic space creating new regional disparities in the process. Bangalore — India’s Silicon Valley
— epitomizes how changing patterns of production and trade links have spurred regional
development. The metropolis that Jawaharlal Nehru called “India’s city of the future” with its
three universities, 14 engineering colleges, and 47 polytechnic schools has been targeted as a center TABLE II
August ’91 to September 96
State Value of Percent of Share of Approvals the value of population
(in Rs. all approvals 1991
Delhi 165.6 19.2 1.1
Maharashtra 114.4 13.5 9.3
Gujarat 57.7 6.7 4.9
Tamil Nadu 50.1 5.8 6.6
West Bengal 49.0 5.7 8.0
Karnataka 47.5 5.5 5.3
Orissa 27.2 3.2 3.7
Uttar Pradesh 24.1 2.8 16.4
Andhra Pradesh 22.1 2.6 7.9
Madhya Pradesh 20.2 2.3 8.0
Punjab 8.0 0.9 2.4
Harayana 6.9 0.8 2.0
Rajasthan 5.1 0.6 5.2
Kerala 5.1 0.6 3.4
Himachal Pradesh 3.2 0.4 0.6
Bihar 1.1 0.1 10.2
Jammu & Kashmir 0.8 0.1 0.9
Others 255.2 29.2 4.1
All India Total 863.3 100.0 100.0

Sources: “Foreign Investment Approvals and Actuals: A Profile,” Economic and Political Weekly
(May 10, 1997) pp. 987; and Statistical Outline of India 1994-95 (Bombay: Tata Services Ltd., 1994)
pp. 40-41. of Indian science since the days of the British raj. While it is home to modern industrial giants like
Hindustan Aeronautics and Bharat Electronics, its most dynamic sector is software. Bangalore’s
“Sultans of Software” include firms with technological expertise matching the world’s most
sophisticated software firms. Their satellite links with software developers around the world led
American economist John Stremlau to observe, “In cyberspace, Bangalore and Boston are practically
in the same space.” Many of Bangalore’s software firms are located in one of the city’s dozen
“technology parks.” These self-contained communities usually have their own satellite
communication system, power, sewage, and often their own stores, schools, and health care facilities.
Life in these communities is increasing detached from the rest of Bangalore, not to mention India’s
rural hinterland.
Commodity chains can involve “low-tech” as well as high-tech industries. Usage of
computerized embroidery machines along with incorporation into multinational marketing networks
has enabled the dusty provincial city of Tiruppur in the south Indian state of Tamil Nadu to increase
exports from $25 million in 1986 to an estimated $1 billion in 1995. Tiruppur’s 100 big exporters
and 1500 suppliers employ a total of some 150,000 workers, making the city one of the few places
in India where there is a labor shortage. Tiruppur’s garment makers are already increasing their value
added by moving from tea-shirts to sportswear, nightwear, and industrial garments. The city’s
producers sell to a broad array of companies including the trendy Italian firm Benneton. Although
many production facilities in Tiruppur remain sweatshops and wages for many workers are barely
above subsistence levels, many workers have acquired new skills, and some have started their own
small firms. There is little doubt that export led growth has benefitted localities Tiruppur. The key
issue is how widely the benefits of exports can be spread. Will localities like Bangalore and
Tiruppur become islands of prosperity amidst an ocean of poverty? Is it possible to create linkages
that spread the benefits of development? Comprehensive analysis of this is beyond the scope of this
paper. What is important for the purposes of this paper is that linkage with global production
networks is likely to reorganize the economic geography of India in dramatic ways increasing
regional disparities in the process.
Many regions of India during its pre-colonial and colonial eras were more closely linked to
the global economy than during the first four decades of the post-colonial era. However, the new
linkages that are being established are not simply taking India “back to the future.” Prior to
independence India was not integrated into a single polity, even under the British. The mosaic of
polities that was India made it difficult for, say, Kashmiris to complain about growing economic
disparities between themselves and say, the Malabar coast. The economic regime of the first forty
years of the post-colonial era made vigorous efforts to promote national unity by minimizing regional
economic disparities at considerable expense to the country’s economic dynamism. Central planning
was used to build infrastructure in undeveloped areas and investment licensing was utilized to
promote industrialization in backward states. Despite these efforts, and in part because fiscal
resources and policy-making authority were increasingly concentrated in the central government,
regional economic disparities produced violent political conflict in the Punjab, Kashmir, Darjeeling,
Chotanagpur, etc.
The economic liberalization that has accompanied globalization may have produced one
development that may mitigate the political tensions resulting from regional disparities. India’s
extensive state economic intervention and its centralization of authority during the post-colonial era
politicized decisions affecting the distribution of benefits among regions. By extricating the state
from the economy, economic liberalization may de-politicize issues of regional equity. Nevertheless,
given the tremendous social heterogeneity that differentiates India’s states and the history of
contention over regional disparities in economic development, regional disputes are likely to gain
prominence on India’s political agenda even if they do not undermine the stability of Indian
democracy. Alleviating tensions from regional disparities has been a long-standing challenge for
the government of India. The challenge will be to resolve the problem by finding new forms of
cooperation that are compatible with market forces and local government initiative.

Concluding Remarks
This essay has focused primarily on foreign portfolio investment in the private sector and to
a lesser extent foreign direct investment. Its use as a test for the impact of other modalities of
financial globalization such as bank loans and foreign aid is somewhat limited. Furthermore, since
India, unlike other developing countries, has yet to experience volatile inflows and outflows of
portfolio investment, it does not examine the impact of the volatility of foreign portfolio investment
on India’s democracy. Nonetheless, my findings raise important questions about the view that
foreign investment is detrimental to democracy. By discovering ways that foreign portfolio
investment has strengthened India’s democratic institutions, the essay highlights several ambiguities
in the relationship between financial globalization and democracy.
To understand the impact of financial globalization on Indian democracy we must first
analyze the relationship between India’s financial sector and Indian democracy prior to globalization.
This analysis provides a baseline that is necessary to comprehend the consequences of financial
globalization. I have contended that prior to globalization, India’s stock exchanges were highly
inequitable. These market institutions allocated the power to appropriate an unfair share of
economic benefits to a small number of stock brokers, privileged members of corporate India, and
corrupt bureaucrats and politicians. When domestic institutions and actors are inequitable and
unaccountable, the transfer of control from local market institutions to more remote international
institutions does not undermine democracy. True, transferring authority to international
organizations dominated by international investors may restrict the ability of a country’s democratic
authorities to control domestic stock exchanges in the future. But before domestic institutions and
actors can be made democratically accountable, they must be subject to the rule of law.
Financial globalization reduced the scope for the arbitrary exercise of authority and
strengthened Indian democracy by promoting liberal norms that expanded the “rule of law” on
India’s stock exchanges. The point here is not that international investors are less susceptible to the
blandishments of corruption than India’s domestic investors and brokers — on the contrary, the
participation of foreign banks in the Harshad Mehta scam is evidence of their willingness to exploit
opportunities for corruption. Rather, the argument is that international investors, as a class, have a
collective interest in rationalizing capital market institutions to enhance predictability and
calculability. International investors also have access to institutions like IOSCO, U.S.A.I.D., the
World Bank, etc. which promote their collective interests. Financial globalization, by providing the
opportunity to attract additional capital, has enhanced the Indian state’s interest in rationalizing its
capital markets. It was in part to attract foreign capital and also to improve its capacity for raising
and allocating domestic capital more efficiently that India created the Securities and Exchange
Board of India, the National Stock Exchange, and other institutional and legal reforms.
The impact of financial globalization on domestic politics is mediated by India’s political
institutions and structures of power even as it changes them. It is by no means inevitable that
financial globalization will eliminate corruption and inefficiency. In some cases, it may create new
opportunities for malfeasance. My argument is that in India it is likely to reduce the arbitrary
exercise of authority within stock exchanges and ultimately in corporate management. This trend
enhances protection of investors’ interests. In India, it is the twenty to thirty million small investors
that suffer the most. It improves India’s economic performance by increasing the efficiency of
resource allocation and corporate management. By curtailing corruption in capital markets, it
strengthens India’s democracy because the corruption inevitably spills over into the political system.
This is true not only for India, but for countries around the world as diverse as Russia, Japan, Brazil,
and Korea.
While it may be analytically useful to adopt a definition of democracy limited to formal
democracy or polyarchy, it remains important to realize that changes in inequality will inevitably
affect the capacity of different citizens to make democratic institutions accountable. It is too early
to grasp the impact of financial globalization on inequalities between economic strata. While there
has been a remarkable increase in the incomes of corporate executives and a patent growth of middle
class consumerism, unlike other developing countries where economic liberalization has been
accompanied by devastating cuts in social welfare expenditures, social welfare expenditures have
increased as a percentage of Central Government expenditures during the reform period. Poverty
rates have also declined although the data are not strong enough to support an argument that the
reforms have reduced poverty. One thing is clear, financial globalization is creating a new
economic geography which seems destined to exacerbate regional inequalities, especially as the
regulations to minimize regional disparities under the pre-reform regime are dismantled. These
disparities may create new problems, but at this point, India’s democracy seems too resilient to be
undermined by them. Less consolidated political systems may not fare as well.
The experience of India’s stock markets suggests that foreign portfolio investment
strengthens the rule of law. However, financial globalization may promote the uneven development
of legal systems by advancing laws that protect business and investor interests while leaving civil
law protecting the social rights of citizens undeveloped. Yet the development of a more rigorous
legal framework for investment and business is not antithetical to the promotion of citizen rights.
Historically, liberalism’s protection of property rights generated a legal framework that facilitated
the advance of citizens’ rights. Whether the equity of procedure implicit in the legal regimes
promoted by neoliberalism can provide opportunities for enhancing citizens’ right in the world of
global capital is an important subject for future research.
This study of financial globalization and democracy in India points out important ambiguities
in the process of democratization and the nature of democracy itself. The conventional wisdom is
that political liberalization precedes the transition to democracy. Our case demonstrates that
financial globalization can promote political liberalization in countries like India that have already
made the transition to democracy. Political institutions can change even after democratic systems
are consolidated, and it is important to be sensitive to these changes since they affect politics in
developed as well as developing societies. By promoting liberal norms, financial globalization may
strengthen the economic and democratic institutions by making them more liberal even while it
generates new disparities that make them less responsive to broad segments of society.