Gujarat International Finance Tec-City Co. Ltd (Gift), being developed as India’s first international financial services centre, is suddenly in the limelight. A number of financial services firms have announced plans to set up office there. BSE Ltd is the latest, having signed a memorandum of understanding with Gift SEZ (special economic zone) to set up an exchange for transactions by international entities.
It’s not clear what products will be transacted and how exactly the exchange plans to attract international participants to the new platform. After all, the rules for the new SEZ are not yet finalized. But recent news reports and some statements from Gift officials provide some clues on the plans.
For instance, at the time of BSE’s announcement, a statement by Gift said, “In the absence of an international financial services centre in India, India has lost roughly 50% market share in the two most important India-related products: with rupee and index being mostly traded on foreign platforms instead of onshore trading in such products.” The reference is to the rupee-dollar futures contracts traded on Dubai Gold and Commodities Exchange, and the Nifty futures contracts traded on Singapore Exchange (SGX), which are popular among international traders.
This column has often rued the export of India’s financial markets to these offshore centres. Not that overseas trading of the rupee or Indian equities is a problem in itself; but it’s unfortunate when lapses in policymaking encourage the export of these markets. The government, the central bank and the securities market regulator have all had a role to play in clamping down on financial market participants in some way or the other. See bit.ly/1EAkoxF on how India encouraged growth in the SGX product with its ad-hoc policy on participatory notes.
In promoting Gift, the government will effectively be saying that it has come to a conclusion that it sincerely wants to export financial services from onshore locations, rather than export Indian markets to offshore locations. While the change in mindset is worth heralding, a moot question is why the new worldview should be restricted to Gift or only financial services SEZs, for that matter.
Policymakers should ask: “Which of the services that we want to encourage in India can be achieved in existing centres such as Mumbai? Can the rule amendments or relaxations being planned for SEZs be implemented across the country?” India will be working at cross-purposes if financial firms are forced to engage in regulatory arbitrage and set up offices because of rule differences.
In any case, the constitutional validity of having a different form of the Foreign Exchange Management Act (Fema) in such SEZs will be under question. A news report in The Economic Times suggested that one discussion on the table as far as the Gift proposal goes is settlement of contracts in dollars. This envisages a situation where some Fema rules don’t apply in Gift. According to a senior government official, the current Fema doesn’t allow for such distinctions.
Of course, there’s much more to an international finance centre than exchanges that facilitate international trade on Indian products. At its core, it envisages a world where an international firm can raise funds from a set of international investors, just as when an Indian firm raises funds in London or Singapore. This will involve establishing an entire financial ecosystem, with world-class financial professionals, physical infrastructure, and importantly, rules and regulations that are on par or better than competing centres.
Gift has done well as far as physical infrastructure goes; but that’s just one thing. India has a poor track record with providing international investors clarity on laws. Since the rules for financial services SEZs aren’t yet laid out, it’s premature to comment on whether Gift will be able to attract international investing and saving community.
According to an expert in market microstructure, policymakers have the tough task of framing rules that can attract international firms and capital, while at the same time safeguard Indian firms and their balance sheets. Attracting international participants from other centres, he envisages, will involve framing rules that are not very stringent. But this, of course, carries higher risks, and while many Indian firms will be happy to function out of a low-touch regulation zone, this will be far from desirable from a policy perspective. It’s another matter if the capital of international firms is at risk.
It remains to be seen if the government’s rules for financial services SEZs will strike this delicate balance. Of course, another point of view is that going down this path will bring with it concerns about creating a Mauritius-type structure within India. Because of this lack of clarity on rules under which Gift will operate, there are more questions than answers.
But while policymakers are at it, they must harness their desire for facilitating international transactions and welcoming foreign capital by moving quickly and changing on India’s archaic financial regulations. Whether they choose to do this by adopting the Indian Financial Code or another set of rules, time is of essence. Else, the move to promote Gift alone will come across as a half-hearted and half-baked attempt to promote Indian finance.
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