For a long time, there has been a realisation that India’s policy mistakes on capital controls, financial regulation and taxation will induce a hollowing out of Indian financial markets. Here is an example from May 2012. The two most important products are Nifty and the rupee, and these are increasingly dominated by overseas activity. Non-residents have a clear choice about where they wish to send their order flow and locals are also known to evade capital controls and take their custom to more competitive venues. There is an amplified concern about these problems this week – see Mobis Philipose in Mint and my article in Business Standard.
These developments are good for the real economy, as superior mechanisms of financial intermediation are displacing the inefficiencies of the onshore financial system. This reduces the cost of doing business for foreign investors.
But at the same time, we in India are losing massive financial service exports as the business is shifting out. On the rupee, the estimated loss of revenue for India is around Rs 60,000 crore per year. Similar values are likely to prevail for Nifty.
In many developing countries, the lack of macro/finance policy capabilities led to a comprehensive hollowing out of domestic financial markets. This is the scenario that is being posed before India.
The correct solution to this problem lies in going to the root cause, and solving our mistakes of financial regulation, capital controls and taxation. This painstaking work has been analysed by the Standing Council on the International Competitiveness of the Indian financial sector, which was setup by the Department of Economic Affairs in June 2013 in recognition of this problem.
Men and nations will do the right thing after trying every reasonable alternative. But what are these ‘reasonable’ alternatives?
Ban The Product
I remember a time when the Reserve Bank of India requested the United Arab Emirates central bank to force DGCX to not trade INR futures. Such a ban is not in the interests of either DGCX or the UAE, and this request was not accepted.
Block The Participants
RBI has tried to say to international firms operating in India: do not trade in India-related financial markets overseas. But the jurisdiction of RBI is limited. There are concerns about non-rule-of-law methods of harming firms who do not obey. RBI and the Securities and Exchange Board of India periodically try to ban participatory note trading.
These bans are futile as India’s regulators have no ability to enforce these bans.
In any case, even if the ban is effective, all that will happen is that the business will move from firms that comply with India’s grab for extra-territorial jurisdiction to firms that do not care about India’s regulators.
Block The Information Products
Nifty is made by IISL, which is an India-domiciled information company.
IISL is not a financial firm and is not exposed to RBI or SEBI regulation. But perhaps non-rule-of-law techniques of coercion can be applied. Suppose this succeeds, and IISL does not license Nifty to SGX.
SGX has numerous alternatives. SGX can go to a mom-and-pop index provider who makes a Nifty-like index: an index where 49 of the 50 stocks are the same as those in Nifty. SGX can shift to the MSCI India index, and MSCI can gently move closer to the Nifty composition.
If, somehow, SGX is prevented from having an effective exchange-traded Nifty product, the business will just go OTC.
Conclusion
Let’s not lose sight of what is going on. There is a trading venue that offers lower costs in investing/trading on Indian assets. We are discussing tools for protectionism through which the cost of participating in the Indian economy is driven up. This is not in India’s interests.
Our course of action should lie in solving the Indian policy mistakes of capital controls, financial regulation and taxation.
(This article was originally published on Ajay Shah’s blog as ‘Hollowing out of India's financial markets: Banning trading abroad is not a choice’, on 9 February 2018)
(This article has been published in an arrangement with BloombergQuint.)
(The author is a professor at the National Institute of Public Finance and Policy. This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)
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