Percy Mistry: Acharya's off target, but not completely!

MUMBAI-IFC REPORT-VI

Having excelled himself on the crucial point of PSU banks, Shankar Acharya gets it wrong.

In this last of a six-part series, I will suggest why, in his column on the "Mystery Report" (May 24), Shankar Acharya may have gotten hold of the wrong end of the stick. Acharya's problems with the MIFC (Mystery/Mistry) Report boil down to: (1) Indulgence in blatant 'financial sector boosterism'; (2) Significant diagnostic weaknesses; and (3) A daunting list of recommendations, some of which he thinks are sensible and others bizarre. Let me deal with each of these.

'Boosterism': Acharya alleges that the MIFC Report makes sweeping recommendations for creating an IFC in Mumbai without making "a clear and compelling case". In his view the Report simply asserts that India has no choice but to produce and export IFS and capture a share of the global IFS market. He also thinks it's the wrong assertion; citing the examples of the successful economies of east Asia and southern Europe not having an IFC as a 'must' for economic success. To all this, I have three reactions.

First, the HPEC was not asked to suggest how Mumbai could be 'nurtured' into becoming an IFC. It was asked to recommend what needed to be done to ensure that Mumbai could operate credibly as one.

Second, almost every other commentator has remarked that the Report makes a powerful case for why Mumbai should and could become an IFC. It rests on: (a) India's quasi-continental hinterland market for IFS; (b) Possession of well-endowed human capital, aptitude for quantitative finance, technological prowess, excellent trading infrastructure, and so on; (c) Being in a propitious time zone; (d) Having the know-how for exporting IT services which provides a platform of experience for exporting IFS as well; (e) Proximate regional/global clientele; (f) Mumbai's established capability as India's national financial centre; and so on.

The Report notes that having an IFC would increase India's growth rate by an incremental percentage point or two by increasing resource allocation efficiency through further financial reform and expanding financial services output/exports. It provides convincing quantifiable evidence to substantiate its conclusions on the significant balance-of-payments savings and the potential revenues that could be generated from IFS. Such exports could amount to an estimated $10 billion by 2015 and more than $50 billion by 2025. That would have a net positive impact on the B-o-P account of $100-plus billion by the mid-2020s. Moreover, an IFC in Mumbai would generate 40-50,000 high-level, high-income professional jobs (in finance, as well as in the legal, accounting, IT and consulting professions) with a vast array of indirect lower-level jobs being created in a ratio of 10:1 relative to direct jobs. What else needs to be said to make the case?

Third, Acharya observes that many other countries in east Asia and southern Europe have not needed an IFC in order to develop and grow. But no one is saying that India needs an IFC in Mumbai as a pre-requisite for its development and growth. Of all the economies Acharya mentions, China's is the most similar to ours in size but it has emulated the manufacturing export success of the east Asian tigers by offering an almost inexhaustible supply of even cheaper labour, land and capital for the foreseeable future. The six smaller economies that Acharya mentions are not of continental size and scale. None is likely to need IFS on the same scale as India or China. Those two giants now need IFS on the scale similar to that of the US and EU in the mid-20th century. And where would those continental economies have been without New York and London to globally intermediate their IFS needs?

India has grown differently to all the smaller economies that Acharya mentions and even to China. It is because of its successful history with IT service exports that diversifying into IFS for the global market is likely to prove easier and more fruitful. IFS provide the next natural service export frontier for India to conquer successfully. India has the endowments, attributes and aptitude for doing so; even if it presently lacks the policies, governance and infrastructure.

Diagnostic shortcomings: On this specific charge, by alluding to the unwarranted dilution of the MIFC Report "" on the matter of state-owned banks (SOBs) and the pervasive problems caused by state ownership of so much of the financial system "" Acharya is clearly right. He knows I was opposed to such dilution and resigned for that reason. It was not that the problem was undiagnosed. Some HPEC members (from the SOBs) opposed disclosing the diagnoses, warts and all. The proper alternative for them would have been to recuse themselves from the Report on this particular issue; or express a personal dissent, as they were invited to. But they chose instead to create an artificial crisis in the Committee, and damaged the integrity of the Report in the process, by weakening its internal logic and the linkage of its analysis to particular recommendations.

But having excelled himself on a crucial point, Acharya points to two particular recommendations of the HPEC as seriously flawed. Acharya is sceptical about transferring too much responsibility to Sebi. He feels that Sebi is too young to regulate trading in currency, interest-rate and commodity derivatives. That misses the point. Such derivatives are financial contracts traded on a daily basis like shares or bonds. If Sebi is responsible for regulating trades in capital markets then it defies logic and common sense to not make it responsible for these contracts as well. It would cause immense regulatory confusion for one part of capital market activity (equities and equity derivatives) to be regulated by Sebi and all other capital market activity (bonds, currency trading and non-equity derivatives) to be regulated by the RBI.

Acharya goes on to insult the intelligence of the HPEC by asserting (without any foundation) that it shows "little understanding of the nuances and benefits of an intermediate exchange rate regime of the kind that has served India well for 15 years." Regardless of whether we were long on finance chiefs and short on economists (for which I am eternally grateful to Rakesh Mohan in composing the Committee), the issue is not whether HPEC appreciated the rather nebulous and fictitious nuances and benefits that Acharya alludes to. It is whether Acharya really understands what needs to happen in finance with irreversible opening of the Indian economy being driven by markets at a faster pace than economists and policymakers, wedded to a command-control approach, can cope with.

Daunting recommendations: Finally let me come to Acharya's comments on the long list of recommendations that the MIFC Report makes. I agree that the list is daunting and comprehensive. But I would suggest that this is necessarily so rather than over-indulgence on our part. The HPEC would not have fulfilled its Terms of Reference if it had been less diligent in its coverage of issues. I am much happier pleading guilty to a charge of undue diligence than confessing to a charge of negligence.

The author was the chairman of the committee that wrote the MIFC report. This is the concluding part of a six-part weekly series.

Click Here For The Full Text of The Percy Mistry Column

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