The Hindu Business Line : Mumbai as international finance hub

Developing nations seeking to benefit from financial globalisation should create the ground conditions to benefit from it. They cannot hope to reap gains merely by creating an International Finance Centre. Driven by bankers' dreams, the Percy Mistry panel report seems to expect the tail to wag the dog, says K. SUBRAMANIAN.

A VIEW of the BSE and RBI buildings in Mumbai... Turning the megapolis into a financial hub will call for bridging many a gap.

It is a dream that excites the imagination of Mumbaikars, especially if they are bankers. Not surprisingly, last March, in an address to a business audience the Prime Minister, Dr Manmohan Singh, had said: "Mumbai with all its inherent advantages in terms of human capital and commercial acumen can be positioned as a viable regional financial centre."

It was not an original idea, but what added glitz was the prevailing mood that India, as an emerging giant, should reach out to the financial universe. In the same speech, Dr Singh requested the Reserve Bank of India to study the feasibility of Capital Account Convertibility (CAC).

Even as the RBI appointed a committee to study CAC, Bombay First, a city-based NGO, stepped up its campaign to elevate Mumbai into an International Finance Centre (IFC). It gave a `wish list' to the Maharashtra Chief Minister seeking amendments to three Central Laws — the Banking Regulation Act, the Foreign Exchange Management Act and the Reserve Bank of India Act and to scale down stamp duty and property tax and to provide infrastructure.

Somewhere along the line, the Finance Minister Mr P. Chidambaram, entrusted the study to a High Powered Expert Committee (HPEC). It was headed by Mr Percy Mistry, a former World Bank economist, and included 15 top names in the financial sector. As press reports suggested, Mr Chidambaram had high expectations from the report and spoke passionately in his Budget speech (2007-08) about Mumbai emerging a global financial centre.

On April 2, the HPEC released its report on making Mumbai an international financial centre. It got wide media coverage, though mixed.

Bloomberg's Andy Mukherjee (April 5) went on to say: "The emphasis of this report is on redesigning the architecture of the Indian financial system." Though he called it a blueprint for India to take the leap, he doubted if Dr. Singh would back it.

It is not the case that Mumbai does not have the potential to play a bigger role in international finance. The issue is over its current status and the ability of financial system to cope with the global market.

Over time, Mumbai may truly be transformed into an IFC even as the economy touches higher levels and financial market deepens. It is equally important that the regulatory framework undergoes changes in tandem, both to facilitate this transformation and to shield it from the buffeting foreign winds.

The regulatory framework has to be dovetailed with the politico-economic compulsions of the main (or real) economy and the strategies required to promote and sustain growth. It should meet the demands of all the constituents and not just the financial class. Hence there is `gradualism' in the reform process. In recent years, this approach has been applauded by many economists, including those from the IMF, and cited as a model for others. The HPEC is not amused.

It proposes nothing short of a "shock therapy." It takes it as an axiom that Mumbai should become one and goes about creating a structure to bring it about. Economists have studied the history of IFCs and the factors that promoted them.

Historical Process

A leading economist noted: "The location of international centres is not random. They are where they are because of a historical process that has resulted in certain places offering a cluster of attraction to the banks that have established their activities there."

Many countries and cities within them have competed for the role. The list is long and includes most developed countries. Among the potential centres, Hong Kong, Shanghai and Singapore are mentioned but not Mumbai. PricewaterhouseCoopers published a survey in partnership with New York City ranking cities in nine categories. (Cities of Opportunity? March 20, 2007). They included nine indicators and 32 variables.

The major indicators were a) intellectual capital, b) technology IQ and innovation, and c) financial clout. It ranked in all 11 cities but not Mumbai. New York dominated under the financial clout categories and London came second. In other categories such as intellectual capital, London ranked first.

Low Rating

Last month, the City of London Corporation published "The Global Financial Survey" evaluating the competitiveness of 46 centres. It suggested that London was ahead of New York in all five competitiveness categories: People, business environment, market access, infrastructure and general competitiveness.

Though the Survey mentions Mumbai in passing, it dismisses it with a low rating.

On its part, the HPEC takes note of seven key factors that provide competitive advantage to an IFC. Sadly, unlike other surveys, it fails to study the candidacy of Mumbai giving weight to the attributes. It avers that Mumbai cannot be an artificial centre like some of the tax havens or offshore centres. Nor can it hide as a special zone. It wants it to be rooted in (and serve) India's financial system. As it proclaims, "the call for creating an IFC in Mumbai at this time is implicitly a metaphor for ... deregulating, liberalising and globalising, all parts of the Indian financial system at a much faster rate than is presently the case." It proceeds to plead for an intensive phase of deregulation and liberalisation and looks upon the IFC as a "device to accelerate movement in that direction."

On this premise, it suggests a ten point agenda or what it calls "A temporal roadmap for reform." It is not practicable to exhaust all the items in the agenda or deal with them at length.

Briefly, it includes total capital convertibility. It recommends removal of the Securities Transactions Tax. It suggests revamping fiscal and monetary management. It aims to downsize (or cut to size!) the RBI and expects it to function independently as a central bank in charge of monetary policy a la the US Federal Reserve and not meddle with the exchange rate.

The rupee should float freely. (The HPEC appears unaware of the requirements of the Humphrey-Dawkins Act of 1978 and Congressional hearings.) It wants rule-based regulation to be replaced by principle-based norms. It is not clear how this will work in practice in a democracy. It suggests a Financial Services Modernisation Act (FSMA) as an omnibus Act encompassing all securities trading, banking, insurance and commodity-finance. Significantly, the HPEC advises the government to disinvest all its shares in banks and financial institutions. In short, it seeks to create a paradise for private bankers with no regulator peeking over their shoulders.

By and large, it is a bankers' view of globalisation and does not take into account recent theoretical developments on the nature of relationship between capital and economic growth in the context of globalisation. There are doubts about the earlier view of benign relationship between capital and growth.

In a seminal study (Financial Globalisation: A Reappraisal, IMF Research Department, No.WP/06/189, August 2006), four leading economists have examined the relationship. One of the major findings is that there is a fundamental tension between the costs and benefits of financial globalisation that may be difficult to avoid. "Financial globalisation appears to have the potential to play a catalytic role in generating an array of collateral benefits that may help long-run growth. At the same time, premature opening of the capital account in the absence of some basic supporting conditions can delay the realisation of these benefits, while making a country more vulnerable to sudden stops of capital flows."

They argue that various threshold effects play an important role in shaping the macroeconomic outcomes of financial globalisation. These are broadly: "the level of development of domestic financial markets, the quality of institutions and corporate governance, the nature of macroeconomic policies (including the exchange rate regime), and the extent of openness to trade."

Countries meetings these conditions are better able to gain from financial globalisation.

The moral is that developing countries wishing to benefit from financial globalisation should create the ground conditions to be able to benefit from it. They cannot hope to reap those gains merely by creating an IFC and dismantling the regulatory framework. Driven by bankers' dream, the HPEC expects the tail to wag the dog.

(The author, a former Finance Ministry official, has extensive experience in international, financial and trade issues.)

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