ASHOK V. DESAI
Why should India have an international financial centre (IFC), when there are more basic things to worry about like wheat and oil? That is because India is importing a large volume of financial services — $13 billion in 2005-06 according to HPEC. Every transaction involving foreign exchange involves some international financial services (IFS); and Indian companies are borrowing and raising capital abroad. So, India already provides a market for IFS; it should also produce services for that market.
The Tatas went to foreign bankers to finance the Corus buyout because no Indian bank could have raised the required $18 billion. They probably paid something between half a billion and a billion dollars on it which Indian bankers could have earned — if only there had been an IFC in India.
But HPEC does not want India to produce IFS for itself alone. It thinks that we have competitive strengths that could make us very efficient producers; we could become big exporters of IFC. This is one industry in which we would have a decisive lead even over China. For we have millions of Anglophone accountants, managers, programmers, bankers — just the kind of people who run IFCs elsewhere. In fact, Indian professionals play an important role in most major international financial centres.
And beyond imports and exports of financial services, an efficient, diversified financial industry enables a country to achieve growth with less investment. The US has a large IFC in New York; it has achieved higher growth with less investment than Japan and Germany, because its IFC transfers funds to their most efficient users.
A financial industry has to be diversified. It should trade in three types of products — bonds (instruments for raising money such as shares, debt and warrants), currencies, and derivatives (markets that enable investors to pass on risks to someone else for a price). Markets for all three should be well developed. They should be as liquid as possible. Liquidity is increased by the volume of funds in a market — which is why an IFC must try and attract funds from all over the world. IFCs of the world compete; and those IFCs win, which regulate with the lightest touch which impose the shortest set of rules and burden participants with the least red tape.
How, then, does Bombay compare with London, the world’s biggest IFC? HPEC rates it on 6 factors relating to markets, 11 relating to institutions and 9 relating to services offered. London gets 10 on 23 out of the 26 points, 9 on two and 6 on one — an average of 9.8. Bombay gets 5 on five, 4 on three, 3 on four, 2 on seven and 1 on twelve — a mean of 2.5. IFCs do not segment the activities of financial institutions: they do not normally prohibit any institution from taking on an activity. HPEC takes 19 activities and 10 types of institutions. Of the 190 possible combinations, 96 are prohibited in India. Banks still have to be licensed by Reserve Bank, which limits competition to protect its daughters, the government banks. Less competition means higher charges and poor service. It means less growth, and smaller financial institutions: eco-nomies of scale are lost. And it means slower innovation; and innovation is very important in the financial services industry.
And what limits competition in the Indian financial industry? Its administrative overburden. India has chosen to have separate regulators for banks, stock exchanges, insurance companies and so on. Each guards its turf, and prevents firms from another branch from entering its own part of industry. What they all fear is scandal. So, they make rule after rule to make sure no scam ever occurs. In doing so, they define the way business is to be done. When confronted with an innovation, Indian regulators typically ask: will the client of the innovator understand the innovation, or should I insert a few clauses to protect him?
Will it introduce new risks, and if so, should I not introduce a few caveats to eliminate those risks? Might it be used for tax evasion, and to ensure it does not, should I not refer this to the tax authorities? Is it permitted by existing law, and if not, should I not write respectfully to the finance ministry to draft a new bill?
In India financial regulation has put so many roadblocks in place that financial innovation can take place only at snail’s pace. Worse, the road to financial innovation in the 21st century cannot be travelled at any speed by regulation that results in India’s financial firms remaining the equivalents of antediluvian Ambassadors and Fiats in India’s financial services industry when the rest of the world is using BMWs and Ferraris.
