As the new decade begins, there is considerable merit in systematically embarking on expanding the level and scope of international financial services (IFS) in India.
IFS includes such activities as fund raising,asset management and global portfolio diversification, mergers and acquisitions, corporate treasury management operations and financing public-private partnerships.
While Mumbai is the most logical centre for further developing IFS in India, others such as the proposed Gujarat International Financial Tech-city (GIFT) could act as a complementary centre.
It may seem odd to stress the need for developing IFS during the fragile recovery from the global financial and economic crisis. The Reserve Bank of India (RBI) has argued with considerable justification that its conservative approach to liberalisation of the financial sector has significantly contributed to mitigating the macroeconomic impact of the current global crisis.
Nevertheless, diminished prospects of the current providers of IFS due to the crisis and subsequent rethinking of the appropriate role of finance; India’s own growth prospects; and its vision of emerging as a major economic power strongly suggest that this is an opportune time to develop IFS in India.
It should be recognised that current and capital account flows invariably involve IFS transactions. The 2007 report of the committee set up by the finance ministry (known as the Percy Mistry Committee Report) has estimated that even under conservative assumptions, purchases by Indian households and firms of IFS will be nearly $50 billion by 2015, and could exceed $120 billion by 2025.
In 2008, India had a merchandise trade deficit of $116 billion, and a trade surplus of $19 billion on services trade, resulting in a total trade deficit of $97 billion. The merchandise trade deficit is likely to continue to remain high. IFS purchases envisaged would lead to even higher deficits, putting considerable pressure on India’s balance of payments and exchange rate.
India’s consolidated true fiscal deficit is projected at nearly 13% of GDP in 2009-10. India’s public debt already exceeds 85% of GDP (a maximum of 60% is considered to be sustainable). The fiscal and current account deficit together would have serious repercussions on macroeconomic and financial stability.
Developing IFS would be one of the policy initiatives to manage this macroeconomic challenge.
India must chart a road map for making fiscal policy consistent with goals of the Fiscal Responsibility and Budget Management (FRBM) Act. It is hoped that the report of the 13th Finance Commission, under the chairmanship of Vijay Kelkar, would emphasise the urgency of fiscal consolidation and suggest a roadmap to achieve it.
The focus of the first phase should be on creating a competitive environment for providing IFS required by domestic economic agents within India. As the Mistry Committee has rightly emphasised, this would involve developing more sophisticated bond-currency-derivative (BCD) markets within India, requiring more substantive financial sector reforms.
Thus, impediments to the development of corporate and municipal bonds markets need to be urgently addressed. India is rapidly urbanising, but the governance and management of urban centres have not received requisite resources and reforms.
Municipal bond markets and public-private partnerships could help provide urban amenities, which are essential for attracting and retaining talent and expanding the urban economic base.
While there are considerable private sector institutional capabilities in the financial sector, more rapid and extensive divestment of public sector banks, albeit in a phased manner, merits serious consideration.
Deeper reforms of corporate governance and management structures of public sector financial institutions and concomitant rationalisation of the role of the RBI are also needed. The reported concern of the public sector banks about the need to develop requisite human resources is welcome, but must be approached systematically with complementary changes including upgrading technology and management information systems.
In recent years, India’s public sector banks such as State Bank of India, and insurance companies such as Life Insurance Corporation have been increasingly involved in joint ventures with foreign partners, and have been targeting markets abroad. They could be encouraged to locate more of the required IFS for their international operations within India. India should also aim to attract financial institutions from other countries, including from East Asian countries such as Japan and Korea, to provide IFS from India.
India aims to be a knowledge economy as application, diffusion, and development of knowledge is acknowledged to be a major contributor to economic growth. India’s infrastructure financing needs and the increasingly sophisticated domestic and international operations of Indian companies will significantly expand the need for financial sector knowledge workers.
India has a large domestic economy and a pool of knowledge workers in the financial sector. Currently many of them are making contributions outside of India. Similar to government’s plans of attracting knowledge workers in the health sector, appropriate incentives and amenities need to be provided to attract and retain knowledge workers in the financial sector.
In this context, GIFT’s recognition of the need to develop knowledge workers from across the country to Gandhinagar is to be welcomed as it is consistent with India’s aim to be a knowledge economy while providing productive employment opportunities. If Mumbai is to become a centre for IFS, it will need to respect merit and welcome Indians from all parts of the country.
The development of IFS in India primarily for domestic needs should be the first priority. This phase may last perhaps a decade. As India’s financial and capital markets acquire greater depth and size, in the subsequent phases, India could consider serving the needs of international clients and become a global financial centre. It is therefore clear that the policymakers and the stakeholders need to sustain their efforts and focus over a long term, and plan sequencing of this process carefully.
The Mistry Committee Report has provided many helpful steps regarding this process. The recommendations of this report should be combined with that of the Raghuram Rajan Committee Report (2008) initiated by the Planning Commission, which focused on the entire financial sector, and with the 13th Finance Commission Report, which is to be released in February. It is now time for concrete actions and policy initiatives to develop IFS in India.
Mukul Asher is a professor (firstname.lastname@example.org) and Azad Singh Bali (email@example.com) a research associate at the Lee Kuan Yew School of Public Policy, National University of Singapore.
Views are personal.