How Finance SEZs can matter

Indian Express, 17 April 2015

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 on the activities which are naturally ours -- rupee and nifty -- India's market share has gone down from 100% to 50% in recent years. Domestic financial sector reforms are moving slowly. In that situation, there is merit in exploring Finance SEZs such as GIFT City in Gujarat.

When TCS thinks of raising capital, it can choose between going to London or Singapore or Bombay. The trading in shares or bonds of TCS can take place anywhere. Governments utilise financial services all over the world: e.g. Sri Lanka's government could choose to sell bonds in London or Singapore or Bombay. Fund managers tend to locate in, and trade in, successful financial centres.

India has a natural opportunity to host international financial centres, owing to ample access to the skills of risk taking, mathematics, computer programming, accounting, etc. India would benefit if this happened, from two points of view. First, it would create millions of high paying jobs, thus giving GDP growth and tax revenues. Second, Indian users of financial services would be better served by access to a globally competitive financial system. For an analogy, the Indian buyer of cars is better off because Indian car companies are now world class and exporting cars.

For the top 100 companies, capital can be accessed overseas, and their fortunes are less tied to Indian finance. But all other companies tend to be unknown in London or Singapore, and are given a raw deal there. For everyone in India other than the top 100 companies, a strong financial system in India matters.

There was once a sense that India would gradually become an international financial centre, and the day would come when the Sri Lankan government or Sri Lankan companies would come to Bombay to seek financing. From 2007 onwards, the reality has gone in the other direction. In the activities which should be our core business -- the rupee and nifty -- the market share of India has dropped from 100% to 50%. This flows from 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, 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, where the financial system walks off to New York.

Deeper changes to 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 deeper change, but the picture today is worrisome.

In the 1960s and 1970s, similar problems were faced on trade openness in India. The political barriers faced against trade liberalisation were, then, quite onerous. In that situation, progress was achieved by setting up Export Processing Zones such as Kandla or SEEPZ. These small elements of opening were useful in the learning process for Indian firms and the Indian government. Export oriented industries like diamonds and software began in SEEPZ, and once it was understood that India has a winning recipe in these areas, the reforms of the mainland gained momentum.

There is merit in utilising this approach for Finance SEZs such as GIFT City in Ahmedabad: to undertake the deep changes in financial regulation, capital controls and tax policy so that financial firms operating in Finance SEZs have the opportunity to compete with London and Singapore. A good model to utilise is the relationship between Hong Kong and China. China's capital controls are eased when it comes to doing business with Hong Kong, so that Hong Kong becomes a potent financial system, and gateway into globalisation, for China.

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 of certain technical attributes is made, the customer does not care how and where the ball bearing was made. In contrast, financial services are intricately bound to the place of manufacture. A currency futures contract in India will be trusted when SEBI and CBDT is trusted; when 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. Sound regulatory institutions are required for enforcing sound laws. The key components of the Indian Financial Code must be the applicable law, good institutional capacity needs to be setup to enforce these laws. The institutional capacity that is built here will be useful, at future dates, in reforming the mainland.

As with the role of SEEPZ in diamonds and software, we should not see Finance SEZs as the destination state. The software that can be produced in India is vastly greater than the software that could have been produced in SEEPZ. In similar fashion, what India can achieve in financial services exports vastly exceeds what is possible under a narrow Finance SEZ. The policy planning for Finance SEZs needs to be integrally connected up with the reforms of RBI, SEBI and CBDT.

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