G N Bajpai: The road to RFC

India has the potential to be the financial hub of the region

In an article written in this newspaper on March 30 ("A regional financial centre"), I stated the benefits and criteria of a regional financial centre, giving examples. In this piece, I argue what India should do to claim that status.

India can now claim to be a regional financial centre because of its high GDP growth and steady integration with the globally integrated economy.

The micro structure of financial markets here is by and large sound enough to accommodate the change. However, there are rough patches to be smoothened, and a few policy initiatives to be taken.

For example, it would be wise to allow foreigners to own assets and take part in cross-border trade staying in their own countries, and grant them the authority to give instructions to stockbrokers, custodians, depository participants, and other intermediaries, and travel to India without a problem in obtaining visa, etc.

The road ahead can be segmented into: (a) refinement/restructuring and (b) policy initiatives.

The Indian capital markets' micro structure is up-to-date, in fact superior in the areas of clearing, settlement and the custody of securities.

Shorter settlement cycles, central counter party, comprehensive risk management, the real time monitoring of broker positions and margins, 100 per cent electronic settlements, and straight-through processing are the hallmarks of the capital markets.

However, appropriate changes in the depository system, securities transactions, custody environment and the movement of assets will be necessary to facilitate faster, freer and easier execution and transferability in the ownership of securities and assets.

India's market depth has increased considerably in the past three years. However, absorbing a greater flow of money, domestic and global, requires facilitating the introduction of more securities in the market.

New/additional capital issued by the private sector would be inadequate and must be substantially supplemented by public sector disinvestment.

This is urgent to prevent manipulation of the market, in particular by large global players, and is relevant even in the current setting.

Over a period of time, as the economy grows, it will become a market-driven corollary.

The rules and regulations for the issue and trading of Indian depository receipts (IDRs), drafted and approved by the ministry of company affairs and Sebi, may have to be refined because the job was done some time ago.

This will help companies from other countries to raise money in India. This cross-border activity will provide opportunity to Indian investors to diversify, take advantage of wealth creation outside India, and to some extent balance the flight of capital.

Likewise, through this process, subsidiaries and outfits of global multinationals that have set up shop in India can raise resources, thereby benefiting Indian investors.

Futures trading in commodities has come back after half a century. But the monitoring mechanisms and control systems are woefully deficient and the regulatory apparatus is appallingly inadequate.

This needs to be strengthened even for the stability of the financial system. The financial futures market has shaped well.

Its regulatory and operational systems are globally comparable. Indeed, India, in a short time since the introduction of financial futures, has made rapid strides and become the largest and fifth biggest markets in the world in single-stock futures and index futures, respectively.

Replicating systems, processes, and control mechanisms with appropriate customisation can bring faster results, as against reinventing the wheel.

The modernisation of the banking system has not kept pace with the developments in the capital market. The Indian banking industry, particularly its public sector component, has to be strengthened in terms of capacity, capability, and technology.

Internationally, the banking industry has moved far beyond deposit taking, borrowing and lending. Globally, most banks have turned into umbrella organisations and financial behemoths, providing for all types of financial intermediation, and capable of undertaking large-size business transactions and absorbing risk to a significant extent.

Building entrepreneurial skills and risk-taking capacities, with a view to harnessing opportunities, and making fuller utilisation of capacities to ward off the impact of cyclical changes in industry, the financial system, and the economy, must receive urgent attention.

The insurance market in India is thin. It requires size and, more importantly, spread. The public sector remains lethargic and the private sector is not able to find its bearings.

There is vast, untapped potential. There are a number of inhibiting factors like the cap on the equity participation of foreign partners at 26 per cent, and the limited capacity of the Indian partner to pump in additional capital.

Insurance regulation and supervision are still evolving and should gather momentum.

India's debt market is under-developed and opaque. Sebi's initiatives to bring debt trading on the transparent and automated path of the exchange platform have been a non-starter.

It takes a long time to raise debt, the procedure is burdensome, and the costs are high. The system does not afford opportunities for paper rated less than A to attract investors.

New ventures cannot proffer AAA, AA or A+ rated paper to begin with. It is only over a period of time that enterprises can build the financial strength to reach investment grade levels.

In fact, the regulatory restriction preventing investment in below A-rated paper compels these organisations to look for equity.

And the equities of such organisations often turn out to be venture capital, to which gullible individuals fall prey. The result is foregone.

The success rate is low and the loss of wealth considerable. This was one of the reasons for the IPO fiasco of the nineties.

Fixed-income futures are traded only on the OTC, leaving transparency issues unresolved and the financial system vulnerable.

The argument that the trading of fixed-income securities and futures is mostly on the OTC across jurisdictions is weak because all the developed markets have exchange-traded debt securities, and futures and options, which help in benchmarking and substantially mitigate the problem of lack of transparency of OTC trades.

In fact, the development of a debt market is a subject by itself and deserves coordinated efforts on the part of the government, the RBI, and Sebi.

The market regulator's efforts in building a vibrant debt market ought to be carried on vigorously.

Policy initiatives: Capital account convertibility and the legal structure are areas to look into. The first is where apprehensions are greater.

Stories of the Latin American crisis and the East Asian meltdown abound and they stoke fears. But it's necessary to look at it from a pragmatic point of view.

From the perspective of FIIs, convertibility is complete and entry and exit are free. Hence bringing in capital account convertibility gradually will be of gain to India.

Legal processes in India are cumbersome, slow and sometimes corrupt. Mere tinkering will not do. Overhauling is crucial. Plea bargaining, universally acknowledged as the most effective regulatory enforcement tool, has to be introduced.

This requires changes in the Criminal Procedure Code (CrPC). One other requirement for a regional financial centre is a trade surplus.

That is difficult to achieve in a short time. The US and the UK do not have a trade surplus even now.

All this may look like another wish list being presented to the finance minister. But the fact remains that because of domestic political and financial stability (to which only India can lay claim outside of North America, Europe, and Japan), India can be the financial hub of the region, like New York, London and Hong Kong.

The author is former LIC chairman and former Sebi chairman