Public Lecture on



By Mr Percy S Mistry

Introductory Remarks

By M. Narasimham, Chairman, ASCI

I have great pleasure in adding my words of welcome to Mr Percy Mistry, who chaired the High Powered Committee, which has recently submitted its Report on developing an International Financial Centre in Mumbai. This is an important Report, marking a definitive step in the ongoing process of liberalisation of our financial sector and, thus could be regarded as a logical sequel to the earlier Reports on the Financial System and Banking Sector Reforms as well as on Capital Account Convertibility.

The backdrop to a study of the issue is the phenomenon of globalisation of financial markets and the growing degree of integration between various national financial markets. The dichotomy between savings and investment, which is the hallmark of financial intermediation, has now spread across national frontiers. We have a situation where the saver is in one country, the investor in another and the transaction is mediated in a financial centre in a third country. The growing interdependence among various financial markets has led to the emergence of what in effect is an international financial market. Globalisation has proceeded apace with a remarkable growth of new service products. Financial innovation has been made possible by the increasing trend towards deregulation of domestic financial markets, removal of controls on cross border capital flows and increasing competition in the international financial markets, with new opportunities to fashion distinctive customised services and create innovative financial products in response to emerging needs. Financial engineering is the name of this game. While the freeing of control over capital movements has provided the basis for international capital flows mediated through financial centres, the remarkable developments in the area of information technology and instantaneous electronic funds transfer has led to an exponential growth in the volume and sophistication of financial services.

These developments have now extended to India in the context of the increasing outward looking orientation of our policies. Financial autarky is no longer an option. It is only appropriate that our markets are involving themselves more closely with international financial market transactions. Indian entities are now participating in the international financial markets by seeking access through the debt and equity routes to international finance. Simultaneously, international financial institutions are getting more involved with India. We are familiar with the increasing importance of foreign institutional investors in our capital markets. Private equity firms are also showing interest in moving funds to this country. Hedge funds are not too far behind. With the progressive upgrading of our credit ratings, which hopefully would continue, we could only expect more of such activity. India is increasingly being seen as an area where people could invest and make money.

Our access to and participation in international finance has been through traditional markets like New York, London and Tokyo and now Singapore and even Mauritius. It is appropriate that we consider the question whether we should not develop an international financial market in this country, to be more precise, in Mumbai. Many years – almost two decades ago, I had argued the case for such a development and suggested, as a first step, the need to develop Mumbai as an offshore banking centre, but for reasons best known to them, the authorities were not receptive to the idea. I presume this had something to do with the apprehension that the then existing offshore centres abroad were seen rightly or wrongly as encouraging tax evasion and money laundering. An offshore centre in Bombay could have provided us with greater exposure to international finance and created a pool of professionals to operate in international finance apart from being a lucrative source of invisible export earnings. An international financial centre is, of course, much wider in scope than an offshore banking centre, and in considering the need and opportunities for such a centre, we need to ask ourselves whether we have the right eco system for its development in the form of software, more particularly skills and the hardware of adequate civic and other infrastructure and efficient state of the art communications network, which would permit real time information on which to act. The recent growth of our IT sector offers opportunities in this area.

One of the important aspects of, what I call the eco-system for developing such an international financial centre, is the pursuit of sound macro economic policies designed to encourage growth with reasonable price stability. We have, in the last few years, a reasonable record in this area though we have still some way to go in the direction of fiscal consolidation and to an eventual elimination of the fiscal deficit, perhaps going beyond the requirements of the FRBM legislation and which would help to reduce the heavy burden of public debt. Our monetary and exchange rate policies also are not aggressive and have followed the dictum of keeping the ship ‘steady as she goes’. Interest rates have been deregulated and are now market determined. Exchange rate policy has also been quite flexible and, given the limited extent of capital account convertibility, we have not so far had to face the problem of the so-called ‘impossible trinity’. We are also moving in measured step towards fuller capital account convertibility.

An equally important foundation for development of an international financial centre is to have a strong internal financial system and a sound, credible and transparent regulatory framework governing its operations. Since the two Reports on Financial System and Banking Sector Reforms, and the Report of the Advisory Group on Transparency in Monetary and Financial Policies and the Tarapore Committee Reports, we have moved a considerable distance in terms of strengthening our financial system through the prescription of sound prudential norms, internationally accepted accounting practices with regard to income recognition and other aspects of accounting and prudential provisioning norms and stipulation of capital adequacy criteria, the last named assuming more importance now so as to ensure compliance with Basel 2 requirements. The pre-emption of banking resources for the public sector has also been severely curtailed. We have also lifted the heavy hand of intrusive regulatory intervention in the operation of financial institutions, almost to the point of micro managing them.

While this is commendable, I am afraid we have not made enough progress in the direction of divestment of Government holding in public sector banks and financial institutions. I sometimes also am concerned at the tendency of our regulators to cast a nostalgic look to the earlier regime and reverting towards directing credit and advising on sectoral interest rates. Our regulatory framework also is reasonably in place, but I sometimes wonder that while the recommendation of the Committee on Financial Sector for a separate body for financial supervision has been accepted, why the function still remains a part of the Reserve Bank. We also have separate regulatory authorities governing capital markets in SEBI, IRDA for insurance and, perhaps in the near future a Pension Regulatory Authority for pensions. The need for coordination between these various regulatory bodies is obvious. Sometimes the point has been made as to whether we should not have a unified regulatory authority like the Financial Services Authority of the UK. I personally believe we need not have such a monolithic institution but to ensure adequate coordinated regulation, we could perhaps consider setting up of an independent Statutory Commission on Financial Regulation, the members of which could be the Governor of Reserve Bank, Chairman of SEBI and the heads of the Insurance and Pension Regulatory Authorities.

A recent welcome development is the decision to take the public debt management function out of the Reserve Bank and set up an independent institution under the Finance Ministry to avoid the possibility of conflict of interest between the Reserve Bank’s monetary function and its debt management function. This is in line with the recommendation of the Advisory Group on Transparency. We thus have still some distance to come in terms of macro economic stability and reforming the regulatory system and moving towards fuller liberalisation of the financial sector. We also have still some way to go in developing efficient and competitive markets in certain aspects of financial development such as those dealing with currency trades and derivatives, but I have reason to hope that this will come eventually. We have another major advantage of having the Rule of Law and a legal system, which provides for protection of contractual rights.

A fully liberalised financial system is a sine qua non for the establishment of an IFC. An internationalised and fully liberalised financial system could provide the basis for setting up an international financial centre which could provide investment and merchant banking and other financial services and serve the capital market not only for the rapidly growing requirements of Indian enterprises and for foreign enterprises wishing to do business in India, but serve also as a financial entrepot for the region.

Another important aspect of what I call the eco system is the availability of the requisite professional skills. International finance is a highly skill intensive vocation but, I believe, we have apart from the familiarity with the English language, the necessary skills, domain knowledge and expertise and supporting professional ability on a less expensive basis than other financial centres, to make a beginning in this area and develop it further. One has only to look around and see the number of Indians in positions of responsibility in the international financial system in various parts of the world to give hope that we do have the professional nucleus to develop this expertise further.

International financial markets are global and are 24 hour long. They are also tripolar, with New York, London and Tokyo being the poles each in distinctive time zones. We in India have a time zone advantage of immense potential as our markets would be open for business during the later part of daily operations of Tokyo and the early hours of trading in London. The participation of Indian entities at present in international financial market is an expensive proposition for them in terms of payment for valuable services rendered. These payments could be retained in India if we develop an international financial centre here. It could also generate fee and other income from business from other countries in the region. The advantages of an Indian IFC for expanding our invisible exchange earning are thus obvious. The example of the City of London, which is a prime source of invisible export income in support of the UK’s balance of payment, is too well known to require repetition. Another advantage flowing from having an international financial centre in India is the help it could provide for our foreign trade especially exports and augment investment flows into and increasingly out of India by assisting Indian corporates as they expand their horizons outside India through mergers, acquisitions and direct investment. If developed on the right lines, it could be a win-win situation.

Victor Hugo once said that “no power on earth can stop an idea whose time has come”. The idea of an international financial centre in India is, I believe, one whose time has come.