 "Percy Mistry raps Budget sops for GIFT City")
Incentives offered in the Union Budget to GIFT City, near Ahmedabad, to emerge as a global financial centre will not bring back the rupee hedge business which has already migrated to Dubai and Singapore, said Percy Mistry, chairman of the Making Mumbai-International Finance Centre (MIFC) committee.
The Budget proposes to reduce Minimum Alternate Tax from 18.5 to nine per cent for GIFT City and waived transaction taxes like STT & CTT, long-term capital gains tax and also abolished the dividend distribution tax.
Read our full coverage on Union Budget 2016
But Mistry said the sops extended to these “useless or counterproductive” artificial IFSC/SEZ entities in the Budget are pointless, wasteful and misdirected. “For a revenue squeezed government to offer these sops at this time, to encourage an activity that is dubious, and possibly counterproductive, is simply idiotic," said he.
Neither the market regulator, the Sebi nor the RBI think that GIFT City or any of the other IFSC/SEZ's is really a workable proposition; but they are both too afraid and timorous to say so openly when the Prime Minister is pushing so hard for this foolishness to occur,” said he.
Mistry had come out with an exhaustive report on how to convert Mumbai into an international finance centre (MIFC) in 2007. The report’s recommendations to open the financial sector to global competition, privatise public sector banks were never implemented.
Mistry said the IFSC/SEZs are not going to bring back the rupee hedge business (e.g. in currency or INR interest rate derivatives) that has already migrated to Dubai, Singapore, London and New York.
“The main players in these markets are FIIs/FPIs and major MNC (foreign and Indian) corporate group treasuries who adopt sophisticated hedging and risk management strategies to manage their Indian cash, debt and equity portfolios against currency and interest rate risks. The counter-parties are large global commercial and universal banks, as well as specialised investment banks, that have a large enough Indian rupee book they can trade against,” said Mistry. That business will continue to be done far more efficiently and cost-effectively in Singapore and Dubai than in any artificial IFSC/SEZ in India like GIFT City.
“That is because the operators in India who attempt to provide the same hedging services, by underwriting the options/futures risk, will be on a steep learning curve. The major Indian banks haven't a clue how to do this business yet; either as hedgers or risk-underwriters (i.e. liquidity-providers). That doesn't mean they can't learn. But, given their extreme capital limitations at the present time, they do not have any advantage in entering this business and playing this game, in artificial offshore financial centres located in India, against far better equipped and better capitalised competitors who are experts in this game and have been doing this business elsewhere for some time now,” said Mistry.
Mistry said the two regulators in India – the RBI and the Sebi -- are completely out of their depth in regulating this specialised type of 'onshore-offshore' risk hedging business. “The tax people will be tearing their hair out trying to figure out what is going on and what income is taxable or not on these very complicated derivative trading books. Usually when that happens, standard regulatory practice in India is to ban anything and everything the regulators don't understand and to play a blame game when anything goes wrong -- which it most certainly will,” said Mistry, a former World Bank economist.
“But, my fear is that to stop themselves looking foolish, they may simply decide to look the other way and let major disasters develop and unfold in the onshore-offshore INR derivatives market, with devastating consequences when things blow up. But, given the implicit pressure that Modi has put on having Minsitry of Finance (MoF), RBI and Sebi officials trying to make these vanity projects of his work, no matter what the cost, they are going along quietly with this foolishness if only to avoid getting in a confrontation with the PMO over something they think may be trivial and containable. But, if it blows up in their faces (and there is a high probability of that happening) it will be neither trivial nor containable,” Mistry said.
The Budget proposes to reduce Minimum Alternate Tax from 18.5 to nine per cent for GIFT City and waived transaction taxes like STT & CTT, long-term capital gains tax and also abolished the dividend distribution tax.
Read our full coverage on Union Budget 2016
But Mistry said the sops extended to these “useless or counterproductive” artificial IFSC/SEZ entities in the Budget are pointless, wasteful and misdirected. “For a revenue squeezed government to offer these sops at this time, to encourage an activity that is dubious, and possibly counterproductive, is simply idiotic," said he.
Neither the market regulator, the Sebi nor the RBI think that GIFT City or any of the other IFSC/SEZ's is really a workable proposition; but they are both too afraid and timorous to say so openly when the Prime Minister is pushing so hard for this foolishness to occur,” said he.
Mistry had come out with an exhaustive report on how to convert Mumbai into an international finance centre (MIFC) in 2007. The report’s recommendations to open the financial sector to global competition, privatise public sector banks were never implemented.
Mistry said the IFSC/SEZs are not going to bring back the rupee hedge business (e.g. in currency or INR interest rate derivatives) that has already migrated to Dubai, Singapore, London and New York.
“The main players in these markets are FIIs/FPIs and major MNC (foreign and Indian) corporate group treasuries who adopt sophisticated hedging and risk management strategies to manage their Indian cash, debt and equity portfolios against currency and interest rate risks. The counter-parties are large global commercial and universal banks, as well as specialised investment banks, that have a large enough Indian rupee book they can trade against,” said Mistry. That business will continue to be done far more efficiently and cost-effectively in Singapore and Dubai than in any artificial IFSC/SEZ in India like GIFT City.
“That is because the operators in India who attempt to provide the same hedging services, by underwriting the options/futures risk, will be on a steep learning curve. The major Indian banks haven't a clue how to do this business yet; either as hedgers or risk-underwriters (i.e. liquidity-providers). That doesn't mean they can't learn. But, given their extreme capital limitations at the present time, they do not have any advantage in entering this business and playing this game, in artificial offshore financial centres located in India, against far better equipped and better capitalised competitors who are experts in this game and have been doing this business elsewhere for some time now,” said Mistry.
Mistry said the two regulators in India – the RBI and the Sebi -- are completely out of their depth in regulating this specialised type of 'onshore-offshore' risk hedging business. “The tax people will be tearing their hair out trying to figure out what is going on and what income is taxable or not on these very complicated derivative trading books. Usually when that happens, standard regulatory practice in India is to ban anything and everything the regulators don't understand and to play a blame game when anything goes wrong -- which it most certainly will,” said Mistry, a former World Bank economist.
“But, my fear is that to stop themselves looking foolish, they may simply decide to look the other way and let major disasters develop and unfold in the onshore-offshore INR derivatives market, with devastating consequences when things blow up. But, given the implicit pressure that Modi has put on having Minsitry of Finance (MoF), RBI and Sebi officials trying to make these vanity projects of his work, no matter what the cost, they are going along quietly with this foolishness if only to avoid getting in a confrontation with the PMO over something they think may be trivial and containable. But, if it blows up in their faces (and there is a high probability of that happening) it will be neither trivial nor containable,” Mistry said.
“All in all, I still think the whole IFSC/SEZ idea is foolish. Providing it with budgetary tax sops to help this business develop (when neither the Finance Ministry, the RBI or Sebi have any idea how many cans of worms they might be opening up) only amplifies that indulgence in official foolishness, to please a PM who does not have a clue as to what this is all about and does not appreciate what the risks (financial and reputational) really are. Those risks have already come home to roost in the case of the state-owned banks (SOBs) and it is clear that the government (i.e. the Indian taxpayer) cannot really afford this,” he said.
On what needs to be done to make Indian financial sector to compete in the global markets, Mistry said it would be far better for India to focus its limited institutional and regulatory bandwidth on liberalising the whole Indian financial system by 2020 including opening up the capital and current accounts completely, over the next four years, and moving from a dirty, managed float for the exchange rate to an entirely market determined exchange rate for the Indian currency in all global currency markets.
“The reason I say that is one only has to look at what is happening in China to understand how risky it is to pretend that officials still have control over 'managed markets' when in reality they do not. They create more problems by prolonging such absurdities,” said he.
Of course, he said, there will be a risk with capital account opening of (inward and outward) capital surges occurring. Every country in the world has experienced such difficulties, whether developed or developing.
"It is not beyond the wit of RBI -- especially with this governor at the helm who, though he is an academic rather than a tried and tested central banker, has at least a faint idea of what he is doing, compared to his predecessors -- to construct appropriate 'tidal basin' arrangements with the IMF (along with complementary swap arrangement with G-7 central banks) that can help to cope with such capital surges, said he.
"That risk is far lower than the risk that will be taken with a relatively institutionally incompetent RBI, and an overburdened if more competent Sebi, trying (with very little domain knowledge and hands-on experience) to regulate a dual regime in complex derivatives markets -- which will inevitably embody immense scope for regulatory arbitrage -- that is operated by weak, insufficiently capable, and under-capitalised, Indian financial institutions in the IFSC/SEZs," said Mistry.