Protectionism, again: Joint action by stock exchanges raises concerns

The joint statement issued by three stock exchanges on Friday — deciding to immediately terminate the agreements for licensing indices and prices of Indian securities to foreign exchanges — raises concerns on several fronts. The action constitutes protectionism, which harms a market (Singapore Stock Exchange, or SGX) that has served global investors well. As with all protectionism, this decision favours one industry (the domestic securities industry) and harms the larger economy as the costs of foreign investment into India have just gone up.

The issue of India’s declining market share in offering financial products with Indian underlying, such as the Nifty and derivatives on the Indian rupee, has led to several concerns of revenue loss for the Indian financial services sector as well as the exchequer. An expert committee constituted by the ministry of finance on assessing the international competitiveness of the Indian financial services sector has listed several problems that need to be resolved to stem the decline of market share of the onshore market. The problems identified by this committee are numerous, ranging from the non-availability of sophisticated financial products that allow people to take positions on Indian assets, tax uncertainty, the sheer administrative complexity of the regulatory framework governing capital flows into and outside India, to rule of law concerns.

The right way to deal with loss of competitiveness is to address the root cause of that. This would require economic reforms by the Securities and Exchange Board of India, the Reserve Bank of India, and the finance ministry. The policymakers have, instead, taken the path of interfering in Singapore’s ability to produce Nifty futures trading. This shows the country in a poor light. There is too much of a readiness to undertake the wrong measures (protectionism) and too little desire to solve the genuine problems.

The decision comes after the SGX started offering single-stock Nifty futures, which account for more than a third of the futures volumes on the National Stock Exchange (NSE). Foreign portfolio investors use such contracts to hedge their exposure in the cash segment, and moving to Singapore reduces costs as contracts are dollar-denominated and offer tax advantage. The manner of imposing this restriction is intriguing, as the joint press release comes from three exchanges. However, it is hard to see how the Bombay Stock Exchange would agree to a measure that essentially amplifies turnover and profits at the NSE. This raises concerns about coercive action by the authorities without the requisite powers and issuance of a legal instrument.

What comes next? The weaknesses of the Indian markets will continue, and those will hobble all users of the market (both domestic and foreign). Foreign investors will feel that the cost of doing business in India is high, that policymakers lack sound instincts, and India will further lose appeal in the global community. The international finance community will also look for workarounds that undermine the action. For example, the SGX will switch from trading Nifty futures to trading futures on the MSCI India index.

The exchanges have left one special clause in their agreement: Licensing indexes and prices is permissible for trading in International Financial Services Centres (IFSCs) but not elsewhere. This is a dangerous milestone. The way for IFSCs to win should be by becoming good at what they do. They should not try to get ahead by harming others doing the same thing. For an analogy, we did not build Santacruz Electronics Export Processing Zone (SEEPZ) by banning import of software from Singapore into India while permitting its import from the SEEPZ.