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China has Hong Kong as an international financial centre, while India has nothing. India is a natural exporter of financial services, owing to the prevalence of the required skills. However, even in the cases of financial services in which we should be the natural market leader — rupee- and Nifty-related trading — India’s market share has gone down from 100 to 50 per cent in recent years. Domestic financial-sector reforms are moving slowly. In such a situation, there is merit in exploring the setting up of finance SEZs such as Gift City in Gujarat.
When, for example, Tata Consultancy Services thinks of raising capital, it can choose between going to London, Singapore or Mumbai. The trading of TCS shares and bonds can take place anywhere in the world. Similarly, governments utilise financial services from all over the world. Fund managers tend to be based out of, and trade in, successful financial centres.
India has a natural advantage to host international financial centres — we have the required skills in mathematics, risk-taking, computer programming, accounting, etc. The country would benefit if financial centres came up here. First, they would create millions of high-paying jobs, resulting in higher GDP growth and tax revenues. Second, Indian users of financial services would be better served if they had easy access to a globally competitive financial system — just as Indian car buyers are better off because Indian car companies are now world class and export their products.
As far as the top-100 companies are concerned, capital can be accessed overseas and their fortunes are less tied to Indian finance. But most other companies are unknown in London or Singapore and are given a raw deal there. For everyone other than the top-100 firms, a strong financial system in India matters a great deal.
There was once a sense that India would gradually become an international financial centre, and that the day would come when the Sri Lankan government or companies, for instance, would come to Mumbai to seek financing. But from 2007 onwards, we have moved in the opposite direction. This is because of the mistakes made by the Indian authorities in financial regulation, capital controls and taxation. At a time when TCS has a market capitalisation of $90 billion, the RBI’s idea of liberalisation is to increase the limit on currency hedging from $10 million to $15 million. India increasingly looks like a South American country with bad institutions, whose financial system walks off to New York.
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Major shifts in financial market regulation, capital controls and tax policy are required. There was a lot of optimism that the new government would have the political will for deep change, but the picture today is worrisome.
In the 1960s and 1970s, similar problems were faced on the issue of trade openness in India. The political barriers against trade liberalisation were, then, quite onerous. In that situation, progress was achieved by setting up export-processing zones, such as Kandla and the Santacruz Electronics Export Processing Zone (SEEPZ). These small changes were important for the learning process of the Indian government and firms. Export-oriented industries like the diamond and software sectors began in SEEPZ. Once it was understood that India had a winning recipe in these areas, mainland reforms gained momentum.
There is merit in using this approach for finance SEZs such as Gift City — deep changes in financial regulation, capital controls and tax policy are required so that firms operating out of finance SEZs can compete with London and Singapore. A good model is the relationship between Hong Kong and China. China’s capital controls are relaxed for Hong Kong. The latter not only has a vibrant financial system, but is China’s gateway to globalisation.
But this is much harder than it seems. In the case of exporting goods, all that is required for an SEZ is to get the Indian government out of the way. Once a ball bearing having certain technical attributes has been manufactured, the customer does not care about how and where it was made. In contrast, financial services are intricately bound to the place of manufacture.
Market players will have confidence in an Indian currency futures contract only when the Sebi and Central Board of Direct Taxation (CBDT) are widely trusted, and orders can be appealed in courts and tribunals that are sensible and swift. Contract disputes will inevitably arise and world-class courts and arbitration procedures will be required.
What is called for is not mere deregulation. A sound framework of law and regulation is required. The key component of the Indian Financial Code must be the applicable law in finance SEZs and institutional capacity needs to be stepped up for enforcement. The institutional capacity that is built here will be useful, at a future date, for reforming the mainland.
As we saw in the case of SEEPZ and the diamond and software industries, we should not look at finance SEZs as the destination. The software that could be produced in India was vastly greater than the software that was produced in SEEPZ.
Similarly, what India can achieve in financial services exports vastly exceeds what is possible under a narrow SEZ. Policy planning for finance SEZs needs to be integrally connected with the larger project of reforming the RBI, Sebi and CBDT.
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