Global finance first

The recommendations of the High Powered Expert Committee on India's role in international financial services call for careful scrutiny.

Within the realm of the economy, the fastest-growing segment is finance, in the broad sense of the term. This is not surprising because in a modern economy finance is the facilitator of all activities. When people buy and sell they use money and a wide range of money substitutes - cheques, credit cards, IOUs (`I owe you' contract bonds) and so on. When people save, they need instruments to hold their savings - bank deposits, mutual funds and shares, for instance. Some of these instruments, typically shares, also represent claims to wealth, and so as wealth increases, more financial activities emerge too. As financial activities grow, they tend to get diversified and new forms appear - equities, bonds, derivatives and the like. In this process, finance comes to assume a measure of autonomy, sometimes as parallel to the "real economy", but increasingly divergent from it. A standard case is where hectic activities in the stock market lead to abnormally high prices of shares, leading to a regime of paper wealth that may be at variance with the real situation, as the dot-com bubble of the 1990s showed.

While these things happen in most national economies, at the international or `global' level, finance comes to have a larger and more visible role. One reason is the fact that national economies have their own currencies and so trade between two countries involves not only a transfer of goods from one country to the other, but also a conversion of their currencies, of Indian rupees into US dollars, for instance. Since the exchange values of currencies change, buying and selling of currencies becomes a profitable transaction. As a matter of fact, trade in currencies now exceeds that in any other good globally.

The movement of capital from one country to others is a further manifestation of finance. Indeed, unless specifically prevented or regulated, free and fast movement from one place to the other, transcending national boundaries, is the natural proclivity of capital. That being the case, financial activities and services today are substantially international.

Some aspects of international financial activity and associated services, particularly their magnitude, are worth noting. Consider the broad category of "asset management", consisting of the way pension funds, insurance assets, mutual funds and the like are administered. The magnitudes are mind-boggling. In 2004, pension funds globally amounted to $18.8 trillion, insurance assets to $14.5 trillion and mutual funds to $16.2 trillion, making a total of $49.5 trillion.

Another source of funds in recent years has been the wealth of those who have a net worth of more than $1 million, some eight million of them globally. They usually hand over their funds to some well-established international bank and the value of such funds in 2004 was over $30 trillion.

All these funds circle the world in search of high returns at unimaginable speeds, thanks to modern information and communication technologies. The wide variety of instruments available to them constitutes one aspect of global finance. Then there are the agencies related to them - dealers, brokers, regulators, administrators - and the legal arrangements. These are the constituents of international financial services (IFS) and today it is the fastest-growing economic activity globally.

What is India's role in IFS today, and what can and should it be in the years ahead? The Union Finance Ministry constituted a High Powered Expert Committee (HPEC) to examine these issues and the volume under review is the committee's report submitted in February 2007.

In the first four decades after Independence, India was not a major player in the global economy or global finance. But this has begun to change since the economy was opened up in the early 1990s. India's global trade has increased substantially, both in absolute terms and as a proportion of gross domestic product (GDP); foreign capital has started moving in steadily, multinational corporations from outside have become visibly active in the Indian economy and Indian companies are making their presence felt in other parts of the world; Indian IT (information technology) services have been establishing contacts all over the world. Each one of these has a bearing on global finances and financial services. And with the economy growing at over 8 per cent annually, global contacts will continue to grow.

But global financial activities do not spread uniformly, and though it may appear paradoxical, global financial services tend to get located in a few cities in different parts of the world. In fact, there are only three cities worldwide that are considered to be truly global financial centres (GFCs) - London, New York and Singapore. They are global in the sense that shares and currencies from all over the world are traded there; they lead in international bank lending; and much of cross-border mergers and acquisitions are transacted through them. There are a few other cities that are classified as international financial centres (IFCs), such as Frankfurt and Tokyo, which have lost out to the three GFCs, and Dubai and Shanghai, which are striving to become global.

What the report considers is whether Mumbai can (and should) aim to become a GFC in the not-too-distant future. The expert committee's view is that Mumbai has the potential and hence should rapidly get going to reap all the benefits that the Indian economy will come to have from Mumbai's new global status.

The HPEC notes that Mumbai already has many attributes required to emerge as an IFC and move on to become a GFC. The big and rapidly growing Indian economy, which is also developing a variety of global contacts, serves as Mumbai's hinterland, similar to the American economy being the hinterland for New York's GFC and Europe being the hinterland for London. Mumbai can claim to have the human capital - generations of experience with entrepreneurship, financial activities, strong skills in information technology and widespread use of English, which is the lingua franca of international finance. Mumbai is also well located in being able to interact with all of Asia and Europe through the trading day.

The committee notes some of Mumbai's limitations also. That Mumbai will have to face competition from Singapore, and Dubai and Shanghai to some extent, is a matter of some concern. More important are the internal limitations, of which the committee has a long list. "Mumbai's deficiencies include: crumbling housing in dilapidated buildings pervading the city; poor road/rail mass transit as well as the absence of water-borne transport in what is essentially an island-city; absent arterial high-speed roads/urban express ways; poor quality of airports, airlines and air-linked connections domestically and internationally; poor provision of power, water, sewerage, waste disposal, as well as paucity of high-quality residential, commercial, shopping and recreational space that meets global standards of construction, finish and maintenance."

The committee is aware that it is not easy to create and govern a first-class global city in a Third World environment, but notes that what Malaysia has managed to do with Kuala Lumpur shows that it is not impossible.

The crux of the problem, according to the committee, however, is something different, directly related to finance itself. One of the key passages in the report is: "The call for creating an IFC in Mumbai is a metaphor for [and synonymous with] deregulating, liberalising, and globalising all parts of the Indian financial system at a faster rate than is presently the case." And to show that it is in tune with what the policymakers want, the committee goes on to say: "Raising the issue of creating an IFC in Mumbai at this time suggests that the need for more intensive liberalisation of the financial system has been anticipated by the policymakers and regulators and that the IFC is an additional device to accelerate movement in that direction."

Specifically, this thrust for further deregulation, liberalisation and globalisation of the financial system includes full convertibility of the rupee by the end of 2008, establishing full independence of the banking system and removing governmental control over the Reserve Bank of India, the immediate creation of a currency spot market with trading in futures, the unification of all financial trading under SEBI (Securities and Exchange Board of India) regulation, replacing rule-based regulation by principle-based regulation and greater freedom for foreign financial firms and for foreign and domestic corporates generally..

Nor are the changes confined to the financial sector. Fiscal and budgetary policies of the Central and State governments also will have to be brought in line with the requirements of global finance. The committee does not go into the details of what that would involve. But it does not call for much effort to see that via fiscal adjustments that are claimed to be necessary, reforms in the financial sector will impact the real economy and the lives of ordinary citizens in many ways. For instance, in order to reduce budgetary deficits, it will be argued that public expenditure will have to be curbed, with subsidies becoming the first target. It will be pointed out, too, that at this stage it will not be prudent to take up even some of the essential welfare measures. In other words, without expressing it openly it will be communicated that economic reasoning indicates that serving global finance is more in keeping with the times than serving the people of this country. Hence the way in which arguments in the report are further developed and the recommendations are attempted to be implemented call for careful and diligent scrutiny.