Capital control

Capital controls were introduced in India many decades ago; so for almost everyone living today, a life in India has been one where the government has had an intrusive system of controls affecting the Indian rupee. There is, hence, a high degree of surprise and novelty in seeing a blossoming of India-related trading, particularly involving the Indian rupee, taking place outside the country. The "non-deliverable forward (NDF)" market is a cash-settled OTC forward market on the rupee-dollar rate. On some days, and for some transaction sizes, the liquidity of the NDF market has come to exceed the liquidity of the Indian rupee-dollar forward market. The recent Mumbai International Financial Centre (MIFC) report has highlighted the trading on Indian underlyings taking place outside the country. It estimates that there is a turnover of $1 billion a day of derivatives trading on the Indian currency and Indian interest rates. In the case of interest rates and credit risk, it appears that the bulk of innovation and market development is taking place outside India. There is no OTC derivatives market on Indian equity in India, but there is a vibrant market of this nature in Hong Kong. As A V Rajwade's article in Business Standard on Monday emphasised, there is a remarkable appetite globally for rupee-denominated bonds. The Inter American Development Bank (IADB)""which does no business in India""has issued a rupee-denominated bond in response to this interest on the part of customers. FT/MCX will soon have an INR/USD currency futures market running in Dubai, at a safe distance from the system of controls that smothers Indian finance.

Owing to the new phenomenon of outbound FDI, every significant Indian company now has arms operating elsewhere in the world. It is now easy for those foreign arms to place orders on these currency/interest rate/credit risk markets, on Indian underlyings, which are taking place outside India. Hence, the international financial services business, which could have been transacted in India, is being transacted outside the country. Instead of India achieving export revenue from selling the international financial services to foreigners, what is happening is that the Indian licence-permit raj in finance is pushing domestic business out of the country into the hands of finance practitioners in Hong Kong, Singapore, Dubai and London.

Indian financial regulators have excelled in banning products and business activities. Every time the staff has been threatened by the intellectual complexity and hard work required in supporting and enabling financial innovation, the government response has been to ban it. What thesedevelopments highlight is that by running a licence-permit raj within India, the ministry of finance and its clutch of agencies are presiding over a shrinking component of Indian finance. Indian companies will increasingly get their equity issuance, bond issuance, risk management, etc. done from overseas providers, who benefit from world-class regulators as is found in London or Singapore.

The global game of international finance is, to a significant extent, competition between regulators. There is no alternative for the ministry of finance but to build up the staff quality of the RBI to match the Bank of England in doing monetary economics; to build up the staff quality of Sebi to match the Financial Services Authority in dealing with policy and regulatory questions on currency options or interest rate futures.