Report of the High Powered Expert Committee on

Making Mumbai an International Financial Centre

Report of the High Powered Expert Committee on

Making Mumbai an International Financial Centre

Ministry of FinanceGovernment of India

New Delhi

Report of the High Powered Expert Committee onMaking Mumbai an International Financial CentreMinistry of Finance, Government of India, New Delhi

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The High Powered Expert Committee (HPEC) on

Making Mumbai an International Financial Centre

The Hon. P. ChidambaramMinister of Finance, Ministry of FinanceGovernment of India, North BlockNew Delhi

th February

Dear Honourable Minister:

We submit herewith the ’s Report on Making Mumbai an International Financial Centre.Our choice of the term ‘International’ instead of ‘Regional’ has been explained in our report.

Yours sincerely,

M. Balachandran O. P. Bhatt

C. B. Bhave Bharat Doshi

K. V. Kamath Nimesh Kampani

K. P. Krishnan (Convenor) Subodh Kumar

Ravi Narain Ms. Usha Narayanan

P. J. Nayak Aditya Puri

N. Mohan Raj T. T. Srinivasaraghavan

Acknowledgements

HPEC would like to place on record its grateful thanks to Ajay Shah, Kshama Fernandes,Saugata Bhattacharya, Ritu Anand, and S. Ravindranath who constituted the Research Teamthat supported the Committee.

The also wishes to express its appreciation to Mr. M. Balachandran who putthe facilities of the Bank of India at the disposal of the Committee. The and theGovernment of India would like to acknowledge their appreciation to the Bank of India formeeting the administrative expenditure for the production of this report.

Contents

Executive Summary xiii. International Financial Services () and Centres (s) in Perspective, xiii.—. Implicationsfor India and Mumbai, xiv.—. The difference between and , xv.—. What areInternational Financial Centres (s) and Services ()?, xvi.—. Growth and globalisationdrive India’s demand for , xviii.—. India’s competitive advantages in creating an , xix.—.Financial regime governance: policy and regulation, xx.—. Reorienting the financial systemtowards provision: A temporal roadmap for reform, xxiv.—. Urban infrastructure andgovernance in Mumbai, xxviii.—. The choice, xxx.

. The Emergence of IFCs: A brief history . Meeting cross-border trade, investment and other needs, .—. Evolution of internationalfinancial services () and centres (s), .—. The first round of globalisation: circa –,.—. An interregnum, the second round of globalisation (–), and beyond, .—. The‘take-off ’ of second round globalisation after , .—. Classification of s, .—. Why didTokyo and Frankfurt not emerge as credible s?, .—. The Race to establish more s aroundthe world, .—. Implications for India and need for Mumbai to emerge as an , .

. st Century IFS provided by IFCs . Fund Raising in s: What is involved? Who does it and how?, .—. Asset management andglobal portfolio diversification, .—. Personal wealth management, .—. Global transferpricing, .—. Global tax management and cross-border tax optimization, .—. Global/regionalcorporate treasury management, .—. Global and regional risk management and insurance/re-insurance operations, .—. Global/Regional exchange trading of securities, commodities andderivatives in financial instruments and indices in commodities, .—. Financial engineering andarchitecture for large complex projects, .—. Cross-border mergers and acquisitions (M&A),.—. Financing for public-private partnerships (), .

. Case studies: London, New York, Singapore, Dubai . Summary overview, .—. A closer look at the City of London, .—. New York/Chicago as theGFC for the Americas and the World, .—. Singapore as the /Asian GFC, .—. Dubaias a RFC for the Middle East and South Asia, .

. Domestic and Offshore demand for International Financial Services (IFS) in India . Implications of a large, rapidly growing home market for IFS, .—. India’s growing integrationwith the world, .—. The impact of globalisation on demand and on s, .—.Estimates for consumption by India, .—. Projections for consumption by India, .—.Implications for India’s aspirations to create an in Mumbai, .—. customers outsideIndia as a market for an in Mumbai, .—. International comparisons, .

. Augmenting IFS provision via BPO . How does an produce ?, .—. An outsourcing approach to provision andIFC development: Possibilities, opportunities and pitfalls, .—. A opportunity: Assetmanagement in Mumbai based on algorithmic trading, .—. IFS subcomponents amenableto outsourcing, .—. Making progress along two paths: Evolution and , .—.Conclusion, .

. Market deficiencies in Mumbai that inhibit the provision of IFS . The context in which Mumbai must develop and evolve as an , .—. Inadequate currencyand bond markets ( Nexus), .—. Missing currency & derivatives markets: An illustration,.—. The market weakness of institutional investors, .—. A cross-country comparison, .

x R M I F C

. The macroeconomic fallout of an IFC . Introduction, .—. Implications for fiscal policy & deficit reduction, .—. Financing publicdebt differently, .—. The mutuality of interests in modernising debt management and havingan , .—. Implications for monetary policy, .—. Outlook for the current account deficit,.—. Macro-stability for an , .—. The incompatibility of capital controls in a st century, .—. Full capital convertibility and an in Mumbai, .

. Financial Regime Governance: Its role in an IFC and a comparative perspective . The intrinsic value of regulation for production, .—. Three levels of internationalcompetition on regulation and law, .—. Where does India stand? An illustrative bird’s eyeview, .—. The overall legal regime governing finance, .—. Summary of cross-countrycomparisons, .

. What are the limitations of financial regime governance? . Where do we stand? An – Market× Players matrix, .—. A pragmatic view of key areasfor progress, .—. Lessons from applying competition policy in the real economy, .—.Artificial segmentation of the financial services industry, .—. Barriers to financial innovation,.

. Why does financial regime governance have these limitations? . Why is the pace of financial innovation slow?, .—. Proximate underlying reasons that are notas transparent, .—. Deeper sources of dysfunction, .—. What impedes Mumbai frombecoming an ? A summary, .

. Reforming financial regime governance . A shift toward principles-based regulation, .—. Reducing the artificial segmentation offinancial firms, products, services and markets, .—. Creating an environment conducive to exit,.—. Retail vs. wholesale markets, .—. The role of exchange-traded vs. OTC derivatives inthe BCD nexus, .—. Regulatory impact assessments, .—. Strengthening the legal systemsupporting an , .

. Tax policy for an IFC in Mumbai . Does India need an IFC or a Tax Haven?, .—. Tax policy for Mumbai as an : and, byimplication, for India, .—. A modern income tax, .—. Taxation of financial transactions,.—. A Goods and Services Tax (GST) in Finance, .—. Mumbai as an IFC: Tax Implicationsfor Maharashtra and Mumbai, .—. Interfacing tax policy and administration with the financialindustry, .—. Stability of tax policy, .—. Where India Stands on taxes: An internationalcomparison, .

. A perspective on Mumbai’s strengths . Human capital needs for , .—. Democracy, Rule-of-Law and the Legal System, .

. Urban infrastructure and governance . The importance of high quality urban infrastructure for an IFC, .—. Problems of cost,.—. Cross-country comparison, .—. Difficulties in Mumbai from an perspective,.—. Improving urban governance in Mumbai, .

. The HPEC’s recommendations . The general macroeconomic environment, .—. Further Financial System Liberalisation andReform, .—. The challenge of urban infrastructure and governance in Mumbai, .

Selected Bibliography

A. The Committee

B. Comparing existing IFCs against Mumbai

Contents xi

C. Comparing emerging IFCs against Mumbai

D. Chronology of events associated with the effort by Benchmark Asset ManagementCompany (BAMC) to start an Exchange Traded Fund (ETF) on Gold

E. Activities of various financial firms in the areas of operation at an IFC: Wall chart . Fund raising, .—. Asset management, .—. Personal wealth management, .—. Globaltax management, .—. Risk management, .—. Financial markets, .—. Securitiesmarkets, .—. Mergers and aquisitions, .—. Leasing and Structured finance, .—.Project financing, .—. Financing, .—. Insurance and reinsurance, .

F. Abbreviations

Executive Summary

1. International FinancialServices (IFS) and Centres(IFCs) in Perspective

Historically, finance has always been‘international’ in character; capital has rarelybeen immobile. Money has moved freelyacross borders for all of civilisation with goldand silver (in various weights and measures)being global currencies for millennia. But,the freedom of capital was dramaticallycurtailed during the ‘Bretton Woods’ regime,created in , when capital controls wereimposed on war-ravaged, capital-starvedeconomies. With post-war recovery, thatregime broke down in . World financehas since been reverting to its natural statewith the removal of capital controls and thegradual re-integration of national capitaland banking markets; but this time on aglobal scale.

countries opened their capitalaccounts between and . A numberof emerging markets did so in the s– often at the ’s urging. In ,the contemplated making an opencapital account a condition of membership.But the idea was shelved when the Asianfinancial crisis erupted in . That wasprecisely when India first contemplated re-opening its capital account. A series ofsimilar mini-crises occurred elsewhere in engulfing Russia and Latin America. By all these crises were contained. Capitalaccount opening resumed but with reducedmomentum as the and others beganto reconsider its benefits and costs. Thequestion of capital account convertibilitynow weighs heavily on China and India,where financial systems with structuralweaknesses, legacy constraints and varyingdegrees of State domination now confrontthe irresistible forces of globalisation.

Even with an open capital account,some financial services (e.g. depositbanking) remain local and non-tradable.But most financial services are now tradable

across borders: i.e. they are internationalfinancial services (). A cross-bordermarket for has existed over millennia.But it has been transformed in the th andth centuries and grown quite differentlyand more dramatically since . It has alsobecome extremely competitive, with buyersand sellers around the world now having achoice of procuring from competinginternational financial centres (s).

A concrete example of procuring from an would be the raising ofdebt. If Mumbai became an , aSouth African railway project could issuea bond there in the primary market. Itwould wish to do so because of Mumbai’ssophisticated securities markets, along witha number of asset managers in Mumbairunning global portfolios. If the bondmarket was developed, the South Africanbond issue could be denominated.Global investors would buy these bondsand trade them on the secondary marketin Mumbai. Each of these three steps –primary market bond issuance by the SouthAfrican entity, primary bond purchases byglobal and Indian investors, and secondarybond market trading by global players –would generate revenues from the export offinancial services from Mumbai. Creatingan in India requires that Mumbai mustbe viewed as competitive in the eyes of theSouth African railway and in the eyes ofglobal bond investors, when compared withalternatives like Singapore or London.

The global market in the stcentury is one in which competition is drivenby rapid innovation in financial products,services, instruments, structures, andarrangements to accommodate and managemyriad requirements, risks, and a ceaselessquest for cost reduction. Competitiveadvantage in provision depends onseven key factors:

. An extensive national, regional, globalnetwork of corporate and government(supranational, sovereign, sub-sovereign

xiv R M I F C

and local) client connections possessedby financial firms participating in aninternational financial centre ().

. High level human capital specialised infinance, particularly quantitative finance,supported by a numerate labour forceproviding lower level paraprofessionalaccounting, book-keeping, complianceand other skills.

. World-class telecommunications infras-tructure with connectivity around theclock, and around the world.

. State-of-the-art systems, capabilityto help develop, maintain and managethe highly sophisticated and expensive infrastructure of global financialfirms, trading platforms and regulators;systems that are evolving continuouslyto help firms retain their competitiveedge.

. A well-developed, sophisticated, openfinancial system characterised by: (i)a complete array of proficient, liquidmarkets in all segments, i.e. equities,bonds, commodities, currencies andderivatives; (ii) extensive participationby financial firms from around theworld, (iii) full integration of marketsegments, i.e. an absence of artificiallycompartmentalised, isolated financialmarkets that are barred from havingoperational linkages with one another;and (iv) absence of protectionist barriersand discriminatory policies favouringdomestic over foreign financial firms inproviding financial services.

. A system of financial regime governance(i.e. embracing legislation, policies,rules, regulations, regulatory agenciesetc.) that is amenable to operating onglobal ‘best-practice’ lines and standards;and finally

. A ‘hinterland advantage’ in terms ofeither a national or regional economy(preferably both) whose growth isgenerating rapid growth in demand for.

Advances in information and commu-nications technologies () have easedinteractions over a distance and reducedtheir cost dramatically. However, activities

involving complex judgment and intellectu-alisation continue to be clustered at a fewphysical locations, where key individualsmeet face-to-face. This is characteristic ofR&D in computer technology – clustered inSilicon Valley and the Cambridge Corridor– despite extensive use of email, voice tele-phony and video conferencing. India hasachieved a minor miracle with the explo-sion of export revenues from services;yet, these revenues are a fraction of SiliconValley’s. Similarly, routine production offinancial services takes place everywhere.But, the most important and high valuedecision-making functions are concentratedin a handful of s that have effectively(and consequently) become global cities

At present, London, New York andSingapore are the only global financialcentres (s). Many emerging saround the world are aspiring to play a globalrole in the years to come: e.g. Shanghaiand Dubai. Other s in Europe andAsia, like Paris, Frankfurt or Tokyo, connecttheir financial systems to the world. Butthey have lost market share and importancein competing for global for reasonsexplained in the report. The world marketfor is represented mainly by the , and Asia which together account for over% of global . Correspondingly theglobal market is concentrated in thethree s located in each of these regions.

2. Implications for India andMumbai

Given that an in Mumbai must berooted in (and serve) India’s financial system,rather than be an artificial offshore appendix,the call for creating an in Mumbai atthis time is implicitly a metaphor for (andsynonymous with) deregulating, liberalizingand globalising, all parts of the Indianfinancial system at a much faster rate thanis presently the case. Raising the issue ofan in Mumbai now suggests that thepressing need for a new, more intensivephase of deregulation and liberalization ofthe financial system has been anticipatedby India’s policy-makers and regulators

To understand what such a city is see Sassen ().

Executive Summary xv

and that the is a device to acceleratemovement in that direction. An willnot be created quickly in Mumbai, nor willit succeed, if action on further deregulationand liberalisation is not taken in real time.

In sustaining its trajectory as anemerging, globally significant, continentaleconomy, the believes that India hasno choice but to: (a) become a producerand exporter of ; and (b) capture anincreasing share of the rapidly growingglobal market. To achieve thesetwo goals, its financial centre in Mumbaimust compete to become a successful. Incremental growth in the global market is now being driven by thegrowing demands of China, India andA. With its strengths in human capital,a globally powerful services industry, andits own hinterland, India has many naturaladvantages for competing successfully in thismarket. In evolving as an , Mumbai willprobably grow in two distinct phases:

. In the first phase (–) Mumbaimust connect India’s financial systemwith the world’s financial marketsthrough . That is what s likeFrankfurt, Paris, Sydney, Tokyo and ahost of smaller s do now in respectof their national economies.

. In its second phase (–) Mumbaimust develop the capacity to competewith the three established s forglobal business that goes beyondmeeting India’s needs. After , would hope that Mumbai would hold itsown in competing with the other sand acquire increasing global marketshare.

India’s financial services industry willnot become export-orientated, nor derivesignificant export-revenues, if Mumbaifails to become an . That willcompromise not just export earnings from, but the quality, efficiency and range ofdomestic financial services offered in Indiaas well. For Mumbai to become an ,India’s policy-makers and financial operatorsneed to understand fully the nature of andopportunities in: the global market;the activities undertaken in s; and the

gap in capabilities that now exists betweenMumbai and established s.

3. The difference between BPOand IFS

The production of financial servicesworldwide is now fragmented into a seriesof interrelated sub-processes undertakenseparately. Business process outsourcing() of individual processes occurs ata considerable distance from the pointof customer contact where their eventualresynthesis occurs. India is now a highlysuccessful venue for the global financialservices industry. In the last five years, it hasgone beyond simple towards complexknowledge process outsourcing or . Thisis a positive development for India to realiseits ambitions of creating an in Mumbai.Finance-related / builds up skillsin India and increases the ‘mind-share’ ofIndia amongst global finance professionals.

However, there is a substantial differ-ence between / and providing via an . Financial processes that get out-sourced under involve low-value, low-skill tasks. They are codified in a manual thatindicates how tasks are to be performed, con-trols quality/integrity, and measures whetherthey are being done correctly. Once the pro-tocols are in place, the task is performedrepetitively. But some outsourced activitiesin finance, involving research and analy-sis, are moving up the value chain.For example, company financial analysis,credit research, and stock market researchfunctions are now also being outsourced.

Still, the real value in financial servicesprovision remains concentrated in a smallnumber of jobs performed by qualified,super-numerate, imaginative people withthe specialised expertise, experience, domainknowledge and skill-sets to be innovativein designing financial instruments andstructures. Such people have extensive cross-border networks of clients and colleagues.Their work involves fine judgment inmaking decisions covering a vast array ofcircumstances. It cannot be scripted ina manual codifying its mechanics. Suchjudgments rely on intensive interaction,inter-personal information flows, and

xvi R M I F C

complex negotiations among a numberof highly qualified professionals includingfinancial experts, specialised corporatelawyers, accountants, tax experts, etc. Suchinteraction takes place at an .

From an Indian perspective, furtherprogress with expanding the /chain in financial services (horizontally andvertically) is inevitable and positive. But thatshould not be confused with what is requiredto provide the full array of via an .Intuitively, moving up from / to afully fledged is analogous to moving upfrom low-end programming to replicatingSilicon Valley. Incremental progress in theIndian industry will not bring SiliconValley to India; that requires a quantumleap. Similarly, doing more /for the global financial services industrywill not, as a matter of course, result inIndia automatically graduating to providing through natural evolution. /will be done by specialised sub-contractorswith different skill sets and competencies. can only be provided by qualifiedand internationally known financial firms;which is what Indian financial firms mustquickly strive to become. India’s growth in/ is about doing more through services firms (like Infosys, Satyam, Wiproor ). India’s growth in is aboutexporting through established and newfinancial intermediaries.

4. What are InternationalFinancial Centres (IFCs) andServices (IFS)?

Financial centres that cater to customersoutside their own jurisdiction are referred toas international (s) or regional (s)or offshore (s). These three differentadjectives are often (but wrongly) usedsynonymously in the literature. Yet thesethree types of s are difficult to definein a clear-cut, mutually exclusive fashion;although they are quite distinct. All thesecentres are ‘international’ in the sense thatthey deal with the flow of finance andfinancial products/services across borders.But that description does not differentiatethem sufficiently in terms of their scope.

We categorise s in this report in fourways; i.e. as:

Global (GFCs ) These are centres that gen-uinely serve clients from all over theworld in the provision of the widestpossible array of ;

Regional (RFCs) They serve their regionalrather than their national economies(see below) – examples of such swould be Dubai or Hong Kong;

Non-global and non-regional, ordinary inter-national IFCs These are centres likeParis, Frankfurt, Tokyo and Sydneythat provide a wide range of butcater mainly to the needs of their na-tional economies rather than theirregions or the world – one might betempted to call them national s al-though that term is an awkward onebecause its two defining adjectives arecontradictory; and

Offshore (OFCs) These are centres that areprimarily tax havens for wealth man-agement and global tax managementrather than providing the fully arrayof .

The products and services thats provide include the following elevenactivities. s provide all of them. Others provide some combination of them.

a. Fund Raising: for individuals, corpo-rations and governments (sovereignand sub-sovereign). This includes debtand quasi-debt across maturity/currency

Singapore and London are also regional in thesense that they serve Asean and the while New Yorkserves North and Latin America. But because thesethree centres serve the global economy, well beyondmeeting the needs of their respective regions, weclassify them as global rather than regional. In thatsense, the sees limited potential for Mumbaito be a regional financial centre for South Asia givencurrent geopolitical realities. South Asia is more likelyto be served by Singapore and Dubai for the time being.We see Mumbai being an that serves India in thefirst stage and leapfrogs to serving the global economyin its next stage of evolution. Ironically, Mumbai as an is likely to serve its region after it serves the world,rather than before. For that reason, although the was asked to look into Mumbai becoming a regionalfinancial centre we dispensed with that characterisationearly on in the knowledge that it would be misleading.Throughout this report therefore we refer to Mumbaibecoming an international rather than a regional FC.

Executive Summary xvii

spectra; equity and quasi-equity for pri-vate, public and public-private corpora-tions; as well as risk-management appen-dices attached to primary fund-raisingtransactions to ensure that the risk expo-sure of the primary borrower or fund-raising entity (to currency, interest rate,credit, market, operational and politicalrisks) does not exceed tolerable limits.

b. Asset Management and Global Port-folio Diversification: undertaken by avariety of national, regional and globalasset managers including, inter alia pen-sion funds, insurance companies, in-vestment and mutual funds of varioustypes characterised by nature of instru-ment (i.e. debt, equity or convertibles),geography, or sector of activity.

c. Personal Wealth Management (PWM):for high-net worth individuals (s).This activity is estimated to involve themanagement of personal assets of $–

trillion worldwide. Overseas Indiansare estimated to hold financial wealth(i.e. apart from real estate, gold, art,etc.) of over $ billion and totalwealth of over $ trillion. PWM takesplace in established s, but is moreskewed towards specialised -sin the Channel Islands, Switzerland,Luxembourg, Monaco and Lichtensteinfor the and Africa; Caribbeanoffshore centres for the and LatinAmerica; Bahrain and Dubai for theMiddle East; Singapore, Hong Kong andsome Pacific Island offshore centres forEast/North Asia.

d. Global Transfer Pricing: This is anactivity that o, like most governments,looks askance at, but needs to realiseand accept the reality of, in a globaleconomy dominated by transnationalcorporations. This will becomeincreasingly important to Indian firmsas they evolve into multinationals.

e. Global Tax Management and Cross-border Tax Liability Optimisation:which provides a business opportunityfor financial intermediaries as well asaccountants and law firms until nationaltax regimes begin to converge towarda global low tax norm. This activity

will become increasingly important toIndian firms as they evolve into s.

f. Global/Regional Corporate TreasuryManagement Operations: involvesfund raising, liquidity investment andmanagement, asset-liability and dura-tion matching, and risk-managementthrough insurance and traded deriva-tive products for currency, interest-rate,credit and political risk exposure.

g. Global/Regional Risk Management Op-erations and Insurance/Re-insurance:which involves highly developed ex-change traded and tailored derivatives(futures, options, swaps, swaptions, capsand collars) as well as world class deriva-tives exchanges that trade a variety ofglobal contracts.

h. Global/Regional Exchange Trading ofFinancial Securities, Commodities andDerivatives Contracts in Financial In-struments/Indices and in Commodi-ties: There is an increasing tendency to-ward multiple listings of financial securi-ties (equities and debt), and of derivativeand commodity contracts, on differentexchanges with emerging investor de-mand for x x trading of all listedsecurities across all exchanges. Demandis highest for the securities of index-corporations in each major capital mar-ket. It will gradually cascade downwardsto cover global trading of all listed se-curities in all markets – developed andemerging. Mumbai is better placed thanmost s to meet this demand, becauseof its human capital and capability,as well as its world-class exchanges andimproving exchange regulation.

i. Financial Engineering and Architec-ture for Large Complex Projects: Thisprimarily involves energy and infras-tructure projects requiring funds froma variety of global sources (public andprivate) with attached risk-management.Again, Indian financial institutions andformer FIs have well-honed skills in thisparticular arena.

j. Global/Regional Mergers and Acquisi-tions Activity: This will become increas-ingly important in India and for whicha considerable amount of back-office

xviii R M I F C

/ and due diligence researchwork is already being outsourced to In-dia.

k. Financing for Global/Regional Public-Private Partnerships: This relativelynew activity has emerged on scene withconsiderable force since the developmentof the London Underground PPP. It hasparticular and immediate relevance forthe financing and rapid development ofIndian infrastructure without recourseto the treasury.

5. Growth and globalisationdrive India’s demand for IFS

Since , India has grown rapidly and itseconomy has globalised. As India grows,it globalises faster. That happens throughthe increased share of trade and foreigninvestment in economic activity. Evidence ofthat lies in two-way cross-border flows. Suchflows, on the current and capital accountscombined, rose from $ billion in

(<% of ) to $ billion in

(>% of ). The forces that resulted inthis six-fold increase are intensifying and willfurther accelerate growth of cross-borderflows. The next decade is likely to see cross-border flows growing as fast.

Current and capital account flows in-variably necessitate purchases of . Forexample, current account transactions in-volve payment services, credit enhancement,currency risk management, etc. Capital ac-count flows involve purchase of investmentbanking, legal, accounting, risk manage-ment, research and other similar services.When / enters or exits India, feesare paid to various providers (e.g. com-mercial and investment banks, securitiesbrokerages, exchanges, insurance compa-nies, asset managers, etc.). As India engagesmore with the world, the stock of assets heldin India by foreigners rises. Similarly, thestock of foreign assets held by Indian house-holds and firms also rises. Purchases of riskmanagement services grow in proportionto these stocks which are far larger than thecapital flows of any one year.

It is estimated that Indian householdshave accumulated considerable wealthoutside the country; well beyond the present

limits set by RBI. The ability of Indianhouseholds to move resources across theborder has increased with India’s increasingopenness. The proliferation of Indian soperating around the world – and transferpricing with their subsidiaries abroad –has led to demand for fund-raising,corporate treasury management and globaltax management. With rapidly increasingannual flows, the stock of assets outside thecountry controlled by Indian householdsand firms is rising rapidly. These assetsrequire for wealth, asset and globaltax management. All these phenomenaimply inevitable increases in purchasesassociated with the growing size of cross-border flows. Calculations in this reportsuggest that on average, the revenuestream works out to % of the gross flowsacross the boundary.

This translates to about $ billion ofIFS purchases by Indian clients in .

Looking ahead, India’s engagement withthe world will intensify in three ways: (a)reduction in barriers such as customs dutiesand capital controls; (b) improvements ininfrastructure; and (c) greater participationby s (Indian and foreign) in the Indianeconomy. These developments will inducedeeper globalisation of the Indian economyin the coming decade, inducing an upsurgeof purchases.

Our estimates suggest that IFS pur-chases by Indian households and firms willrise to $ billion by on the basis ofconservative assumptions in a ‘base-case’scenario. Under more propitious circum-stances (e.g. if GDP growth is sustained at%) that figure could be over US$ billion.By that amount could exceed US$

billion in nominal terms.These estimates warrant a different way

of thinking about exports and aboutan in Mumbai. Traditional conceptu-alising by Indian exporters about marketopportunities typically assumes tapping intoa quasi-infinite world market. Financial ser-

This was the approach taken by the Indian softwareindustry which now has domestic sales of a mere $

million while its exports are a -fold multiple ofroughly $ billion a year. The search for growth onthe part of firms like , Infosys or Wipro has beenprimarily about finding international customers. The

Executive Summary xix

vices are like software services in that they arelabour, skill, /communications intensive.But, in terms of market opportunity, there isa fundamental difference between financeand software. It lies in India’s hinterlandadvantage. Rapid growth, even more rapidintegration with the rest of the world, andthe high consequent growth rate of two-waycross-border financial flows now being seen,all serve to make India a large and growingcustomer for . Unlike service exports,India provides a platform for nurturing capabilities that can ‘go global’ instantly.

Against that growing demand for , afailure to respond on the supply-side, (i.e.by creating a successful in Mumbai)will simply oblige Indian customers todo increasing business abroad. Thatwill fuel the growth of Singapore, Dubai,London and other s while deprivingMumbai of capturing opportunities for highvalue-added exports. For example,the Tata Steel-Corus deal generated revenues in Singapore and London. Someelements of such transactions do not appearin Indian BOP accounts. Financial firms andpolicy makers in the three s and are highly attuned to the opportunitiesfor selling into India. They haveembarked on strategies that exploit thecurrent infirmities of the Indian financialsystem. The most capable Indian financialfirms are likely to move to these centres inorder to acquire the flexibility to providetheir extant client base with the theyneed, rather than risk losing their clients toglobal financial firms.

Rapidly growing demand for inIndia provides an opportunity for itsfinancial services industry that its softwareindustry never had. Indian software exportswere generated by ingenious Indian humancapital exploiting foreign markets andrequiring nothing from the State otherthan telecom reforms. Indian geniusconquered world markets between and in a way that was not imagined in eventhe most optimistic forecasts of . Inthe case of , an identical opportunity

domestic market does not loom large to the s ofthese firms, and played no role in their graduating intoexport-oriented MNCs.

exists for Indian financial genius to achievesimilar export success in world markets;but with one key difference. India’s owngrowth and globalisation, and consequentdomestic demand for , generates naturalopportunities for producers in India(local and foreign) to acquire skills andexploit economies of scale. Indian softwareexports required an enabling frameworkfrom the State in the form of telecomreforms. Indian exports will requirea similar enabling framework from theState. Deeper and wider reforms andimprovements are needed in: (a) India’sfinancial system and the way it is governedand regulated; as well as (b) Mumbai’s urbaninfrastructure and political/administrativegovernance on a scale not yet envisaged.

6. India’s competitiveadvantages in creating anIFC

Hinterland Advantage: As argued abovethe growth of the Indian economyand more rapid growth of cross-border financial flows have createdsubstantial local demand for . This‘driver’ supports the development ofskills, and generates economies ofscale on the part of financial firmsoperating in Mumbai. China has thesame hinterland advantage. New Yorkhas the North American economy asits hinterland. London has the evenlarger economy, as well as its ownnational economy, to serve. Singaporehas a limited national economy. Butit is the financial epicentre of anA regional economy that isalmost as large as China and largerthan India. Dubai does not havethat kind of national or regionaleconomy. But it is located in a regionthat is generating enormous financialsurpluses for investment abroad.

Human Capital: India has four strengthsby way of human capital endowmentsthat give it a competitive edge overShanghai, Singapore and Dubai:• The extensive use of English,

which is the lingua franca ofinternational finance

xx R M I F C

• Generations of experience withentrepreneurship, speculation,trading in securities and deriva-tives, risk taking, and accounting.Indeed the ability to provide seems to be genetically coded intoIndian finance professionals

• Strong skills in information tech-nology and quantitative thinking

• Individuals of Indian origin playa prominent role in the top

global financial firms. They arewell-positioned to intermediatebetween the business strategies ofthese vital firms and the genuinestrengths and weaknesses of Indiaas an .

Location: Mumbai is well located in beingable to interact with all of Asiaand Europe through the trading day.Apart from the Americas, transactionswith most of world can occurin daylight. Given the remarkableand growing role of London inproviding global today, India hasthe advantage of having a – houroverlap with London time. There isno operating within an hour’svariation of the Indian Standard Timezone. India has an edge over Shanghai,but not over Dubai, in this respect.

Democracy and Rule-of-Law: Properlyfunctioning financial markets requirea constitutional basis and machineryfor system governance that is stable,reliable, resilient and flexible; i.e.one that reduces future politicalrisks and uncertainty. Globallycredible financial systems need tobe rooted in legislative, judicial, andregulatory frameworks that adhereto rule-of-law and respect/protectproperty rights; in principle andin practice. can be providedcredibly only from environments thatpermit open and honest expressionof independent views by portfoliomanagers, analysts, commentators,researchers, etc. even when such viewscontradict those of governments andpowerful personalities with a vestedinterest. India has proven strengths in

upholding liberal values, protectingproperty rights and maintainingpolitical stability. It fares wellcompared with China, Singapore orDubai but does not match London orNew York.

Mindshare: High growth, the/ phenomenon, and thesuccess of Indians in global financeall over the world, ensure that Indiahas significant ‘mindshare’ at policy-making levels in global financial firms.India has an edge over Singapore andDubai, and perhaps even over China,in this respect.

Strong securities markets and advanced trad-ing platforms: India has the foun-dations for providing global byvirtue of its dynamic, technologicallycapable securities trading platformsin the and . These are therd and th biggest exchanges in theworld measured by number of trans-actions. India has an edge over Chinaand Dubai, but not over Singapore, inthis respect.

Taking these formidable advantages intoaccount, the initial conditions supportingIndia’s entry into the global market for are promising; especially when comparedwith the early days of software exportsfrom India. In the latter case, there wasno hinterland advantage, location did notmatter, democracy did not matter, and therewas no beach-head. The six comparativeand competitive advantages that India has,suggest that there is a genuine opportunityfor India to create a viable able tocompete with the best in providing tothe Indian and global markets in a short spanof time. But, it confronts some dauntingchallenges. Our report highlights these indetail. They include: (a) financial regimegovernance in India; (b) missing marketsand institutions and (c) urban facilities andgovernance in Mumbai.

7. Financial regime governance:policy and regulation

A sound basic framework for develop-ing/applying law and regulation are intrinsic

Executive Summary xxi

to . The quality and credibility of provided from India is inextricably linked tothe soundness and global acceptability of theregulatory/legal system that governs financein India. Global competition in is, toan extent, a function of global competition(in terms of reputation, capability, efficiencyand effectiveness) among regulatory regimesand the institutions that apply those regimes.The market share of an is determined asmuch by the quality and reputation of itsregulatory/legal regime as by the abilities ofits financial firms. A cross-country assess-ment suggests that India is weak on manyaspects of the legal and regulatory frame-work governing its financial system whichthe report discusses in detail. The reportalso identifies two key strategic institutional(or structural) weaknesses in Indian financethat impede production:

• ‘Missing’ Debt, Currency, and Deriva-tives Markets: The most critical finan-cial market components missing in In-dia are: a properly functioning bondmarket, a currency market and a deriva-tives market for currencies and inter-est rates. These three interlinked mar-kets are termed collectively as the bond-currency-derivatives (BCD) nexus inthis report. Six specific deficienciesin this respect include the absence of:(a) a liquid and efficient sovereignbond market with an arbitrage-free yield curve, (b) a wide range ofessential derivatives on interestrates, (c) a liquid spot market for -denominated corporate bonds, (d) creditderivatives on credit spreads or creditevents, (e) a liquid currency market and(f) a full range of currency derivatives.

Under a functional nexus, allsix elements are based on vibrantspeculative price discovery, and aretightly knitted by arbitrage. Theyinteract to result in market efficiency.There is no successful that lacks sucha nexus. Its conspicuous absencein India handicaps the country’s abilityto provide . Another shortcomingis the inadequacy of India’s spot andderivatives markets – in terms of thevariety of contracts traded and their

traded volumes – in all areas other thanequities. A normative rule-of-thumbwould suggest that the traded volumeof an exchange-traded futures contractin India should be at least one-tenth theturnover of a corresponding product inthe . By this yardstick, the turnoverof Nifty futures is about that size. Butthat is not the case for almost all of thetop underlying contracts in the .

• An inadequate universe of institutionalinvestors: The second deficiency inIndia is a universe of institutionalinvestors that have the size, visibilityand capability of those in establisheds. The progress made so farwith liberalisation has been basedlargely on speculative price discoveryby non-institutional investors in equitymarkets. Other segments are dominatedby state-owned entities which arebound by restrictive rules. Banks andinsurance companies are restrained, ifnot banned, from undertaking risk-hedging activities and other kinds ofsophisticated business due to regulatoryrestrictions. Consequently their assetsare growing too slowly.

Indian financial firms tend to operatein one key business segment at atime. Their portfolios are narrowlyconfined and concentrated; so is theirrisk exposure. That has stunted theirgrowth, imagination and ability tohandle risk. Indian financial firms nowneed to evolve into full fledged large,complex financial institutions (s inBasel parlance). They need to operate inall financial market segments of financeto come up with credible offeringsand ‘packages’ for the export market.

India lacks domestic commercial andinvestment banks capable of taking onglobal counterparts without higher levelsof capitalisation, global market access, operational expertise, and high-level human capital. India also lackslarge securities brokerages capable ofcompeting with global counterparts.India’s brokerage industry reflects theinfirmities of its retail sector as awhole. It is characterised by toomany small, undercapitalised, limited-

xxii R M I F C

capability firms (brokers and sub-brokers) that are mostly still singleproprietorships in corporate form.Structural reforms are required urgentlyto create Indian financial firms that areequivalent in size and capabilities toglobal counterparts. Looking ahead,if India is to create an , there is noescape from inviting the participationof domestic and foreign institutionalinvestors of adequate size, who woulddeploy the economies of scale, globalmarket-reach and efficiency-enhancingbehaviour that is evident at other s.

Why does India have these weaknesses?Close scrutiny of the regulatory regimeexamines the origins of these infirmitiesthrough a matrix that identifies and analysesrestraints on the activities of differentfinancial firms in providing various .Such a matrix has been prepared as a‘wallchart’ for this report. It outlinesactivities that take place at s andthe kinds of financial firms that typicallyundertake them. A careful analysis of thiswallchart reveals that, at present, most ofthe activities that take place at sare banned or severely proscribed in India.The red ink across the wallchart – signifyingactivities banned in India – portrays thelicense-permit-control raj that still operatesin Indian finance. It retards developmentand sophistication of the financial sectorand inhibits exports. A pragmatic viewof these constraints highlights three urgent,cross-cutting priorities for reform:

• Competition Policy: India’s experiencewith liberalisation in the real economy,suggests that the most powerful tool forhaving efficient and well-functioningfirms is competition. Application ofsound competition policy in all marketsegments of India’s financial sector isnow a matter of urgency.

• Compartmentalisation of the Finan-cial System: Global competitiveness re-quires exploiting fully the economiesof scale and scope. India’s hinterlandadvantage represents an opportunityto exploit such economies. HoweverIndian finance has been artificially frag-mented by financial sector policy and

regulation. There is no that has socompartmentalised an approach to thestructuring, management and regula-tion of its financial markets. Reversingcounterproductive segmentation of fi-nancial markets in India, and removingbarriers to entry, would result in greater:economies of scale/scope, competition,and global market-reach.

• Inhibiting Financial Innovation:Whether an should be created forIndia to catch up with the world, or to ex-ploit comparative advantage in a global market, a considerably faster paceof financial innovation in India is essen-tial. But, financial regime governance inIndia can only cope with change slowly.The regulatory approach to any changein the structure or functioning of thefinancial system is conservative, cautiousand inconducive to innovation. As aresult India falls behind internationalpractice by the day in every market seg-ment. The default signal emitted byIndian regulators when faced with anynew idea seems to be set at ‘amber’ if not‘red’. Innovative instruments, contractsand new ways of doing business are actedupon in days in the three s. Sucha pace of rapid progress is not foundin India. Basic contracts like interestrate futures and options have failed tomaterialise in this climate.

Deregulation and liberalisation throughthe s have largely unshackled India’smanufacturing sector, and much of itsreal economy. Competition, innovationand scale economies in these sectors areno longer blocked by the State. Yet,somewhat dissonantly, a much higher degreeof control continues to operate in keyparts of the financial sector; despite themany regulatory reforms of the s. Thisfinancial governance regime now needs tobe overhauled to create a more moderngovernance regime. It does not needtraditional fine-tuning with the extantregime remaining largely intact.

Regulatory reform has had a positiveimpact on the functioning of India’s capitalmarkets and the insurance sector. In thecapital markets, India has achieved global

Executive Summary xxiii

standards in some aspects. Other financialmarkets lag behind in not yet having beenreformed as widely or deeply. Despite thepresence of a large number of different typesof banks, and despite incremental measuresaimed at ‘opening-up’, the banking marketin India has yet to improve substantiallyin competition, innovation and efficiency.The improvements achieved at the marginshave not yet permeated the banking systemas a whole. They are unlikely to, withouta major reformative push and diminishedpublic presence.

For that reason, a dramatic changein the governance regime for all financialmarkets in India is now imperative. Withoutit India will not be able to create aninnovation-orientated financial systemthat can evolve and compete at a pacecommensurate with changes in the Indianeconomy and global finance. Such asystem would have the following activitiesundertaken on a par with global norms:(a) continual innovation and improvementin the design of financial products andcustomer services as well as in their delivery;(b) the rapid reintegration of segregatedfinancial markets into more liquid and moreintegrated markets; and (c) the rapid growthand market-induced consolidation of Indianfinancial firms in a manner that enablesthem to achieve economies of scale.

For this to be achieved, Indian financialsystem regulation needs to be brought upto world standards. Regulatory attitudes,policies, practices as well as institutionalarrangements need to undergo a sea-change. They need to become moreattuned to, and supportive of, the dynamism,growth and global competitiveness of theIndian financial services industry. Policyand regulation must adjust and adapt tothe needs of Indian and global financialmarkets. Financial markets should notbe artificially fragmented, segmented,compartmentalised.

This report does not advocate usingthe hinterland argument as a reasonfor protectionism. Nor is the making an argument for ‘self-sufficiency’.Instead the believes that India andIndian financial firms should be globallycompetitive in providing through an

in Mumbai. The goal of publicpolicy is to foster high economic growthand enhance welfare in India; it is notto cater to the interests of Indian firmsor their shareholders. But, in sayingthis, the is mindful of the realitythat developments during the last decadehave resulted in a debilitating anomalyfor Indian financial firms versus theirforeign competitors. In manufacturing,the removal of barriers to imports wasaccompanied by a simultaneous unshacklingof Indian firms. Indian firms were exposedto greater competition from imports andthe entry of foreign s in domesticmarket space. But they were, simultaneously,given a transitional period and considerablefreedom in terms of formulating businessstrategies and innovating.

The evolution of Indian finance,in contrast, has resulted in growingdissonance between external competitionand a repressive license-permit raj. India’slong and tortuous evolution towards de factoconvertibility (which in some respects isnot dissimilar to tariff reductions in thereal economy) has not been accompaniedby Indian financial firms being given thesame opportunity and room for manoeuvreto develop their competitive capabilities.They are at a disadvantage in coping withcompetition (for their clients’ business)from global providers operating in Indiaand from abroad for two reasons:• First, key financial markets (i.e. the

nexus and risk management) havebeen prevented from developing in Indiabecause of regulatory restraints. Thathas resulted in Indian financial firms nothaving the opportunity or the time/spaceto develop domain knowledge and skill-sets in crucial areas e.g. global fund-raising or developing sophisticated riskmanagement products/services tailoredto client needs.

• Second, the same regulatory restraintshave deprived Indian financial firms ofthe freedom they need to develop andthe necessary flexibility in formulatingglobal business strategies. They have nothad the scope for innovating for andthus developing the skills required tocompete with global providers.

xxiv R M I F C

The is clear that, in providing from India, there is no case whatsoeverfor protectionism. The interests of Indiancustomers, and that of economic efficiency,are best served by enabling them to choosefrom the best providers in the world.But, the asymmetry in policy that has placedIndian financial firms at a disadvantage,underlines the case for phasing reformsaimed at creating capabilities in amanner that enables Indian financial firmsto be similarly unshackled in competing toprovide .

8. Reorienting the financialsystem towards IFSprovision: A temporalroadmap for reform

The strategy proposed in this report forcreating an comprises in essence a ten-point agenda:

. Macroeconomic (i.e. Fiscal and Mone-tary) Management.

As a new competitor in globalfinancial markets, the credibility ofIndia’s macro-economic policies, andthe quality of its macroeconomic andfinancial system management, will bejudged more stringently than in the caseof established s. This asymmetricreality highlights the importance ofredoubling efforts in reforming policies,legal and institutional arrangements toachieve and sustain a high growth rate(–%) for the economy in general andthe financial sector in particular.

Creating a vibrant, competitive in Mumbai will require, as an integralbackdrop, success in meeting thelegal commitments entered into bythe Government of India, and thegovernments of individual states, toreduce the consolidated fiscal deficit onthe timeline announced. In addition, itwill require (a) reducing the total publicdebt/ ratio to more acceptablelevels; and (b) pursuing sound fiscaland monetary policies thereafter.

HPEC therefore recommends thatfurther action should be taken toreduce more rapidly the consolidated

debt of centre and states, including on-and-off-balance-sheet liabilities (suchas pensions) and endorses a lowerlevel (than the present %) for thetotal consolidated public debt-to-GDPratio. A public debt ceiling should bebolstered by flexible triggers for actionsto be taken by the Ministry of Finance(e.g. accelerated sales of public assetswhose proceeds are used to liquidateoutstanding public debt if that is deemedappropriate) when the adopted debtratio ceiling is breached. While the did not wish to recommend aparticular debt ceiling ratio withoutlooking more deeply into the matter,global experience suggests that ratios inthe range of –% are widely appliedas prudent. Such a debt ratio should beadded to existing measures fordeficit and debt reduction.

For an Indian to be credible, inkeeping with ‘best-practice’ worldwide,India’s central bank should be indepen-dent and separate from government. Itmust be independent and separate fromgovernment; i.e. in the same way thatthe Federal Reserve in the , the in Europe, the various national centralbanks of Europe and Japan, and the Bankof England, are independent of and sepa-rate from their governments. The centralbank must employ global best-practicesin the conduct of monetary policy, inorder to suffuse international investorsand issuers with growing confidence inthe as an acceptable global currencyfor transactions. The level of con-fidence engendered should permit the to become one of the world’s majorreserve currencies by or at thelatest.

The gold standard for a stabilisingmonetary policy is a transparent,independent, inflation-targeting centralbank. With such an arrangement theIndian State would be: (a) underliningits commitment to delivering low andpredictable inflation; and (b) inducinggreater confidence in the in the eyesof domestic and global investors. The recommends that the Ministryof Finance consider: (a) reforming

Executive Summary xxv

monetary institutions in the lightof recent developments in monetaryeconomics; and (b) doing so in a waythat bolsters the case for a credible in Mumbai.

also recommends a fresh lookat applying key principles in guidingreform of the tax system on the revenueside, to ensure that India remainsglobally competitive, and avoids pricedistorting subsidies on the expenditureside. This has particular implications forensuring that inflation-targeting is notdistorted or rendered ineffective becausesubsidies (e.g. for key energy prices)emit the wrong inflation signals.

. Strategy for Public Debt Financing.Traditionally, India has eschewed

bond issuance outside the country, fear-ing the currency risk that arises withissuing forex bonds while having revenues. This risk of ‘original sin’ doesnot arise if denominated bondsare sold to meet foreign demand forsuch debt. The HPEC therefore advo-cates opening up fully to foreign invest-ment in INR denominated sovereignbonds issued by GoI . It further recom-mends that no limits should apply topurchases by foreign clients of INR de-nominated corporate bonds or bondsissued by sub-sovereign entities (statesand metropolitan administrations). Inaddition, the HPEC believes that thefunction of a public debt managementoffice should be placed in the Ministryof Finance rather than in a regulatoryinstitution to avoid any perceptions ofconflicts-of-interest.

This would achieve two goals. First, itwould open up a new financing channelfor o (and state and municipalgovernments as well) thus enablingit to abandon repressive policies thatpre-empt domestic savings with anarray of undesirable and unintendedconsequences (e.g. crowding out andundue pressure on the interestrate). Second, the internationalisationof bonds (issued by the sovereign,sub-sovereigns and corporates) wouldaccelerate the emergence of an Indian on the world stage.

There is considerable unmet globaldemand for bonds on the partof long-term institutional investorssuch as foreign pension funds. Arapidly emerging bond marketwould trigger currency trading in Indiaand foster the use of currencyand interest rate derivatives. Thatwould facilitate the evolution of the as a global currency, used asa numeraire by bond investors andissuers from India and around theworld. Internationalisation of the (a prerequisite for a successful inMumbai) would expand transactionvolumes in India’s bond, currencyand derivatives markets, as well asits equity and commodity markets,coterminously. It would expand therange of financing options open to,and seignorage revenues derived by, theGovernment of India and its centralbank.

. Creation of the BCD Market Nexus.The most important missing piece

in Indian finance is the nexus ex-plained earlier: i.e. the set of interlinkedbond-currency-derivatives markets forspot and derivative instruments on in-terest rates, currencies and credit risk. Inorder to ignite these markets, HPEC rec-ommends the immediate creation of acurrency spot market, with a minimumtransaction size of Rs. million, acces-sible to all financial firms. In addition,an INR-settled exchange-traded cur-rency derivatives market should be cre-ated, with trading in futures, optionsand swaps on currencies, accessible toall.

These two initiatives, along withdeveloping more rapidly the spotmarket for bonds, need to be mergedinto the existing securities exchangeecosystem so as to trade alongsidethe spot and derivatives markets forequity. The policy problems thathave held back interest rate futuresneed to be rapidly resolved. Theresponsibility for regulation of thesemarkets – spot or derivatives; exchangeor ; government bonds, corporatebonds, and currencies – needs to be

xxvi R M I F C

moved to without further adoand unified with the regulation ofall organised financial trading. Thegoal should be to create and launch asignificant nexus, in conformitywith world standards, within months.

. Financial Market Integration andConvergence vs. Market Segmentation

Indian finance suffers from a frag-mented approach whereby the overallfinancial industry has been cut up intopieces reflecting legislation that is out-dated by years or more. exportswill not take place as long as the com-petencies of Indian financial firms areartificially stunted. India now needs itsown s present in all lines of busi-ness, and able to achieve economies ofscope and scale. A series of measuresare needed to achieve market integra-tion and convergence, and thus enableeconomies of scale, economies of scope,greater competition and enhanced IFSexport capability, i.e.:

. Redraft the legal foundations fororganised financial trading, so asto unify all organised financialtrading under regulation. Thiswould include currencies, equities,sovereign and corporate bonds, andcommodity derivatives. It wouldimmediately diminish some of thefragmentation which has taken placeamongst financial firms.

. Remove barriers to a holdingcompany structure through whichvirtual financial firms can be created,with an array of subsidiaries that fitIndian regulatory constraints butwith corporate headquarters andtop management able to operatea unified financial firm. Theholding company would be regulatedonly by the Companies Act. Itwould typically be listed and able toleverage itself; while its subsidiariesmight be unlisted. All barriers toM&A in finance need to be identifiedand removed, so as to achievea market-induced consolidationprocess which would permit Indians to emerge.

. Create wholesale asset managementbusinesses with freedom for outsourc-ing by existing financial firms such asbanks or insurance companies. Thiswould separate the legal and contrac-tual structures through which assetsare sourced and securities are created– across multiple front-ends acrossthe country – from the ‘factories’ inwhich assets are managed. It wouldalso achieve economies of scale inasset management.

. Shift away from regulation by entityto regulation by domain. As anexample, IRDA would regulate onlythe insurance business, not all theactivities of insurance companies.

. Principles-based RegulationOver the decades India has built

up a license-permit raj in finance.It over-emphasises compliance at theexpense of competence, competitionand innovation in financial services.A similar raj dominated the realeconomy since independence. Butit was dismantled during the sto the immense benefit of the Indianeconomy and particularly Indian globalcompetitiveness. To achieve the sameobjectives, that raj in finance now needsto be dismantled if India is to develop provision and export capabilitiesand if an is to emerge in Mumbai.

At present financial regulation in In-dia is fragmented and rules-based. It isover-prescriptive and restrictive of man-agerial discretion. In every market seg-ment, regulators attempt to codify everydetail of a business in which the shape ofthe future can neither be anticipated norpredicted. Anything not explicitly per-mitted is banned. Any proposed changein the way of doing business requiresclearance from the regulator. Supervi-sors apply checklists in verifying thatevery rule is met while not quite un-derstanding all the dimensions of thebusiness possibilities of the regulatedentity and how it might evolve. Thisapproach is inflexible and unamenableto swift adaptation of a kind that theworld of global finance demands. Thisis counterproductive for the purposes

Executive Summary xxvii

of fostering provision capabilitiesand inappropriate for an .

HPEC therefore recommends thatrules-based regulation in India bereplaced by principles-based regula-tion. That will require redrafting In-dia’s securities and banking laws aswell as re-skilling of all regulatory staff.HPEC also recommends that a newunified Financial Services Modernisa-tion Act (FSMA) be drafted to bringtogether, under a single omnibus leg-islative umbrella, all aspects of finan-cial services: i.e. securities trading,banking, derivatives, insurance andcommodity-finance. Such omnibus leg-islation should reflect the holistic natureof the financial services industry whilecreating the foundations for regulationto be modernised and, possibly, uni-fied in the fullness of time. This newlaw should draw on the models of the’s and the ’ , and bealigned with the shift away from rules-based regulation that is now being wit-nessed around the world. The new om-nibus law should embed an appeals pro-cedure – under an International Finan-cial Services Apellate Tribunal ()– that allows for: (a) appeal against anyaction of any financial regulator in India;(b) broadening the scope of appeal; and(c) judges having specialised domainknowledge in finance.

. Capital Account ConvertibilityThe convertibility question is critically

linked to the possibility of a currency cri-sis, which India has successfully avoidedover –. This discussion needsto be illuminated by three key points.First, the present Indian policy config-uration is not a ‘consistent’ one, givena pegged exchange rate and attempts athaving an autonomous monetary policywhile having significant capital accountopenness. This has, in the past, led topotentially destabilising one-way betsfor foreign capital. Second, it is clearthat if export is the goal, this is in-compatible with capital controls. Third,the growing integration of India intothe world on the current account andthe capital account is giving de facto

convertibility in any case. Myriad othercountries have perfected the combina-tion of autonomous monetary policyand convertibility. India needs to em-ulate the dozens of successes, and avoidthe mistakes made by the few failures.

Having considered the recommen-dations of the Tarapore- CommitteeReport very carefully, the HPEC nev-ertheless recommends that full capi-tal convertibility should be achievedwithin a time-bound period of the next- months and by no later that theend of calendar .

This recommendation needs tobe dovetailed with an - monthtimetable for acting on ’s otherrecommendations. That would kill twobirds with one stone. It would accom-modate the accepted international con-sensus that a country moving to con-vertibility must have liquid and efficientfinancial markets and strong institutions.Also, India’s opportunity to export will really open up after convertibility.So, between now and then, a windowof opportunity exists to tackle issues ofpublic debt management, and missingmarkets/institutions, with forceful reme-dial measures.

. Taxation of IFS and Financial Trans-actions

recommends a rational andfair tax system for which is com-petitive by international standards. The is against creating a tax haven inan Indian .

A key HPEC recommendation en-dorses the Kelkar Committee Report’sproposals for including financial ser-vices under the Goods and Services Tax(GST) regime with the simultaneousremoval of all central and state trans-action taxes including the SecuritiesTransaction Tax (STT), stamp duties,etc. These recommendations should beimplemented as swiftly as possible.

. Inducing greater competition and in-novation in the Indian financial system

has made a series of specificrecommendations in Chapter . All ofthem aim at inducing greater competi-tion and innovation in the Indian finan-

xxviii R M I F C

cial system and in the provision/exportof . Apart from what has alreadybeen said about reversing the excessivesegmentation and compartmentalisa-tion of financial markets, these measuresinclude, inter alia:• Removing existing barriers to en-

try of private domestic corporateplayers in some segments of the fi-nancial services industry;

• Removing barriers to the entry offoreign financial firms in the pro-vision of IFS on the grounds thatunilateral liberalisation is in India’sown interests;

• Restricting demands for recipro-cal market access only to domesticfinancial services;

• Reducing the extent of public own-ership progressively in Indian fi-nancial institutions;

• Removing existing barriers tofriendly or hostile mergers, acqui-sitions and takeovers in the finan-cial services industry within/acrossmarket segments; and

• Encouraging the emergence of In-dian LCFIs through market-driveninitiatives.

. Improving the performance of the legalsystem for finance/ IFS

HPEC believes that significant im-provements need to be made in the In-dian legal system in resolving disputes,adjudicating settlements and enforc-ing financial contracts in real time. Ifthat does not happen the prospects forMumbai emerging as an , or aspiringto become a , will be irreparablydamaged.

. Opening up space for IFS support ser-vices infrastructure

Related to improvements in the le-gal system as they apply to finance and, the HPEC recommends openingup domestic space to permit the en-try of well-known international lawfirms that operate in other IFCs andGFCs as well as international account-ing firms and tax advisory firms as wellas specialist management consultingfirms focusing on the IFS industry. This

recommendation is made so that In-dia can catch up quickly with the restof the world in becoming a competi-tive provider of through an inMumbai. It will not do so if it is left toexisting domestic law, accounting andtax advisory firms to develop domainknowledge and skill-sets organically – incoping with the demands for relatedlegal, accounting, tax and business advi-sory services –without being confrontedwith the pressures of competition andinnovation in their market.Swift implementation of this ten-

point programme, would orientate Indianfinancial firms towards achieving exportcompetitiveness. It has ramifications formacro-economic policy that have alreadybeen spelt out. It is consistent with thepursuit of sound practices in fiscal, monetaryand exchange rate management. Theserecommendations constitute a dovetailedagenda that would be wise for India to followin any event regardless of the arguments foror against an .

9. Urban infrastructure andgovernance in Mumbai

The lure of the burgeoning Indian markethas already attracted a large number offoreign financial firms to Mumbai. Theyhave, in turn, located an increasing numberof high-level expatriate staff in the city,creating intense competition and drivingup prices quite dramatically for limitedaccommodation and lifestyle facilities thatare not yet world class. A Mumbai-that provides only to the Indian marketwill not face the same pressures fromforeign firms and expatriates to remedy theprivations that they presently have to suffer:i.e. inadequate infrastructure, massivecongestion, rampant pollution, along withpoor standards of urban governance and lawenforcement. In ’s view the presentstate of play can be tolerated reluctantly evenas Mumbai grows as an in its first phase,connecting India to the rest of the world.But that can only last for the next five yearsor so.

In its second phase of growth, ifMumbai is to be a successful that

Executive Summary xxix

exports to global markets competitively, itwill have no choice but to match London,New York and Singapore in terms ofattracting the requisite high-level humantalent to the city. If it fails to do so it willnot succeed as a . To match these globalcities in the span of the next - years fortheir world class quality of infrastructureand their global standards of governance,Mumbai needs to make a start now.

The individuals that Mumbai mustattract (and who matter most) to be globallycompetitive in providing – whetherIndian or not and whether working forIndian or foreign firms – are affluent, mobile,and multi-culturally inclined in terms oftheir habits, tastes and preferences. Theydemand world class facilities to live, workand play, as well as world standards ofinfrastructure and urban governance. Theyhave ample choice in terms of where they(and their families) choose to be located,and how their time is allocated. Whetherthey choose to locate in Mumbai will beinfluenced by the attractions of Mumbai as aglobal city in which they can live, work andplay in a manner similar to what they cando in other s. This reality may involvethe creation of facilities to support lifestylesthat could result in increasing social tensionin the city; that risk will need to be managedsensitively and adroitly.

For Mumbai to become an that canoperate on a par with the three establisheds, it will eventually need to attract alarge population of individuals who arean integral part of the globally mobile(globile) finance workforce that already exists.Perhaps –% of them will be of Indianorigin. The remainder will be expatriatesfrom around the world representing everycountry that has significant trade andinvestment links with India (and Asia).Most of them will be working for foreignfinancial firms that will include, interalia: commercial and investment banks,asset management companies, insurancecompanies, securities and commoditiesbrokerages, bills discounting houses, privateequity firms, venture capitalists, hedge funds,as well as the financial media and financialreporting agencies (such as Bloomberg,Reuters, major global financial publications)

and exchanges – even external and globalregulatory agency representatives – fromover a hundred different countries. Toattract such internationally mobile high-level human capital to an in Mumbai,special efforts will be required on four fronts:i.e.

• First, elementary, glaring deficienciesin Mumbai’s urban infrastructure willneed to be addressed and rectified on awar footing. These deficiencies have,over the last decade or more, beendiscussed in central, state and municipalgovernment circles, the media, thecorporate world, and by the publicat large. Progress in addressing thesedeficits is now being made. The was assured by the ofMaharashtra that the pace of progresswas about to accelerate. Mumbai’sdeficiencies include: crumbling housingin dilapidated buildings pervading thecity; poor road/rail mass transit as wellas the absence of water-borne transportin what is essentially an island-city;absent arterial high-speed roads/urbanexpressways; poor quality of airports,airlines and air-linked connectionsdomestically and internationally; poorprovision of power, water, sewerage,waste disposal, as well as a paucity ofhigh-quality residential, commercial,shopping and recreational space thatmeets global standards of construction,finish and maintenance.

• Second, Mumbai will need to beseen as a cosmopolitan metropolisthat welcomes and embraces migrantsfrom everywhere – from India andabroad. That will mean providingmore user-friendly visa/resident permitmechanisms, making all arms ofgovernment expatriate-friendly, andexhibiting a gentle, tolerant, open andwelcoming culture.

• Third, lifestyle facilities that concernhuman welfare will need to be broughtup to world standards and run onworld-class lines in terms of theirmanagement and growth. These include:hospitals and the health system (publicand private); educational facilities

xxx R M I F C

such as primary/secondary schools,colleges, and universities; recreationalfacilities such as sports stadiums (fora wide variety of sports and notjust cricket), gymnasiums, cinemas,theatres, parks, clubs, hotels, bars,restaurants, racecourses, casinos andother entertainment avenues; as well ascultural institutions such as libraries, artgalleries, museums and the like, cateringto global tastes.

• Fourth, the quality of municipal andstate governance, the provision of per-sonal security and of law enforcement,will need to improve dramatically fromthird-world to first-world standards toaccommodate an . That is likely toprove the greatest challenge of all.

Of course, Mumbai needs to tackle theseinfrastructure deficits for reasons other thanbecoming an . The is too smalla tail with which to wag the much largerurban development dog. But the case for an would be immeasurably enhanced if itsucceeds in doing so. For that reason, recommends a fresh attack on the legal issuesof urban governance, in a cohesive effort,undertaken on a war-footing, between theCentre, Maharashtra and Mumbai. Theaim must be to create a city governmentwith the necessary autonomy, accountabilityand power to provide local public goods inMumbai in a reasonably unfettered fashion.Mumbai’s needs must be met irrespective ofrural versus urban considerations. The city’sadministration must have an earmarkedfunding stream through tax sharing, inaddition to user charges and property taxesthat it can levy independently, to finance thecreation of a ‘global city’ in Mumbai.

10. The choice

India has already become a large purchaserof from the rest of the world; muchlarger than is realised in policy-making orcommercial circles, leave alone by the publicat large. As its economy grows, its demandfor will increase in a non-linear fashion.India can, of course, choose to continuebuying from abroad indefinitely. Butthe amounts it will need to spend for thatpurpose are staggering. They represent a

waste of resources on purchasing servicesthat India could provide more competitivelyfor itself. Moreover, an inability to meetits own needs – and those of its tradingand investment partners – for willcompromise India’s growth.

Oddly enough, India does not need torely on foreign providers for . Quitethe contrary: India has several significantstrengths that give it an edge in providing not just to itself but to the rest of theworld on a competitive basis. Indeed, thereis no city in the world that can become an on the scale of London or New York,within a -year horizon, in the way thatMumbai can. This reflects India’s uniquestrengths of: democracy, open-mindedness,cultural comfort with foreigners living andworking in Mumbai, use of English, a wellplaced time zone, high quality labour force,a year tradition of speculation and risktaking, and a hinterland advantage.

But such a future for Mumbai is farfrom guaranteed. At present, India isabsent from the global space, owingto weaknesses in financial sector policy,financial market structure, financial regimegovernance, legal system infirmities, aswell as in the urban infrastructure andgovernance of Mumbai. The situationis worse than initial conditions were formanufacturing and software exports in .India does not have a low market share inthe global market: it has a zero marketshare.

Looking ahead, the growth of demand in India is inevitable, given thesheer growth of cross-border flows. Thepressure of demand that will flow fromcross-border transactions of $– trillion peryear will inevitably trigger the emergenceof rudimentary capabilities in one wayor another. The question that India faces iswhether incremental evolution towards alimited range of capabilities is adequate,or whether there is a more promising futurefor India in exporting .

If decision-makers fail to tackle thepolicy issues outlined in this report, Indian demand will fuel the growth of WallStreet, Singapore, and the Cityof London; often through the aegis ofIndian financial firms that will graduate

Executive Summary xxxi

into multinationals and relocate their operations outside the country.

The maturity of Indian finance in ,in terms of coping with competition andglobalisation, is comparable to where Indianmanufacturing stood in . The exportof financial services from India in

sounds about as unlikely today as the exportof automobile components or softwaresounded in . The outlook for export ofautomobile components or software in

was nothing but bleak. Yet India managedto find the energy to unleash revolutionarychanges in policy.

Such radical changes now need to bereplicated in finance, if export competitive-ness in the provision of financial services(domestic and international) is desired andto be achieved. Visionary thinking needs tobe applied to issues of financial architecture,the role of the central bank, and regulatoryphilosophy.

In parallel, Mumbai needs to become afirst-world city that can attract the brightestminds of the world by being an attractiveplace to live, work and play.

If India is able to meet these twinchallenges, then exports could outstrip service exports by . The benefitsto the Indian economy, from taking the

path, are much greater than thedirect revenues that would accrue fromsale of to local and foreign customers.India’s experience with manufacturing hasdemonstrated that outward orientation andexport competitiveness are the best toolsfor producing world class quality for thedomestic market. An Indian financial sectorthat can export will do a better task offinancial intermediation for India. That islikely to generate an acceleration of growth as growing investment resources(now exceeding % of ) are moreefficiently allocated.

These benefits need to be weighedcarefully by India’s leadership against thepolitical capital that needs to be expendedin overcoming the technical and realpolitikconstraints of: (a) changing the financialsystem in India with a second, moreintensive set of reforms; and (b) urbangovernance in Mumbai.

This report has tried to bring objectivityand professional competence to sketchingthe trajectory, should India’s leadershipdecide to take the path. It strives todeliver a nuanced appreciation of the likelycosts and benefits of the path to an ,based on understanding of which policy-makers can make a reasoned choice.

xxxii R M I F C

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Executive Summary xxxiii

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anci

alse

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mm

itmen

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men

ton

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inpl

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open

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part

icip

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bjec

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and

fitne

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33.I

nter

imad

just

men

tpe

riod

oftw

oye

ars

for

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anin

stitu

tions

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apt

togl

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com

petit

ion.

Cap

acity

build

ing

byIn

dian

firm

sIn

dian

finan

cial

sect

orop

ento

fore

ign

com

petit

ion

34.O

peni

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bran

ches

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mes

ticba

nks

tobe

deco

ntro

lled

imm

edia

tely.

All

rest

rictio

nson

bran

chop

enin

gby

dom

estic

bank

sto

bere

mov

edim

med

iate

ly

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peni

ngof

bran

ches

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reig

nba

nks

tobe

deco

ntro

lled

afte

ron

eye

arA

llre

stric

tions

onbr

anch

open

ing

byfo

reig

nba

nks

tobe

rem

oved

36.R

emov

eim

med

iate

lyal

lres

tric

tions

limiti

ngco

rpor

ate

owne

rshi

pof

bank

sto

10%

Rest

rictio

nslim

iting

priv

ate

corp

orat

eow

ners

hip

ofba

nks

to10

%to

bere

mov

ed

37.O

pen

upIn

dian

capi

talm

arke

tsto

entr

yof

hedg

efu

nds

and

alte

rnat

ive

inve

stm

ent

vehi

cles

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ove

allr

estr

ictio

nson

entr

yof

hedg

efu

nds

and

AIV

s

38.S

etup

rang

eof

prog

ram

mes

ford

evel

opm

ento

fspe

cial

ised

hum

anca

pita

lfor

the

finan

cial

indu

stry

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upM

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nce

and

ara

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tech

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inin

gpr

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ased

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ater

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for

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41.W

ater

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acity

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lines

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ansi

onof

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and

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unde

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crea

sean

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atm

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ood

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ase

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teD

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ity:

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solid

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dw

aste

with

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tect

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ontr

acts

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ting

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elec

omm

unic

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fras

truc

ture

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stan

tialE

xpan

sion

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lar

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wor

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ldce

llula

rop

erat

ors

tose

rvic

equ

ality

com

mitm

ents

toup

grad

eco

ntin

uous

ly

B.Ex

pans

ion

ofLa

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esan

dBr

oadb

and

MTN

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expa

ndla

ndlin

esin

keep

ing

with

dem

and

grow

th;i

ncre

ase

com

petit

ion

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xpan

sion

ofIn

tern

atio

nalB

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idth

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toin

crea

seba

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dly;

intr

oduc

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titio

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44.A

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mod

atio

n:Re

side

ntia

l,O

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and

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mer

cial

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pU

LCR

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Nor

mal

ise

rent

als

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pens

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ithal

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trol

sex

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anni

ng

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vern

ance

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um

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45.G

oMan

dBM

Cto

appo

int

orar

rang

eto

elec

ta

City

Man

ager

acco

unta

ble

for

Mum

bai

Prep

are

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undw

ork

App

oint

/Ele

ctPl

ace

City

Adm

inis

trat

ion

unde

rfu

llco

ntro

lof

City

Man

ager

46.B

ring

the

exis

ting

city

gove

rnan

cem

achi

nery

unde

rth

efu

llco

ntro

lof

the

City

Man

ager

Prep

are

Gro

undw

ork

47.E

stab

lish

inde

pend

ent

finan

cial

base

for

the

city

that

isun

der

the

cont

rolo

fth

eC

ityM

anag

erSt

udy

Opt

ions

Agr

eeFu

ndSo

urce

sPl

ace

City

onm

ainl

yin

depe

nden

tfin

anci

alfo

otin

g

48.R

atio

nalis

ean

dst

ream

line

toor

gani

satio

nst

ruct

ure

and

lines

ofre

spon

sibi

lity

inci

tym

anag

emen

tO

rgan

isat

ion

Stud

yTr

ansi

tion

Impl

emen

tRa

tiona

lisat

ion/

Stre

amlin

ing

Prog

ram

me