New Delhi: India must carry out sweeping reforms such as internationalising the Rupee, easing capital controls and rolling out Goods and Services Tax to make its financial sector globally competitive, an expert panel said in a report on Tuesday, paving the way for the next generation reforms in the coming years.
The Standing Council on international competitiveness of the Indian financial sector, headed by economic affairs secretary, pointed to the opportunity of providing financial services produced in India to a global audience and makes Mumbai one of the top five financial centres of the world.
The reforms are required to make Indian financial markets more liquid, foster domestic financial development, and improve monetary policy transmission and finally pushing up GDP growth.
The Council, which comprised eminent experts like SBI chairman Arundhati Bhattacharya, UTI AMC MD Leo Puri, NSE vice chairman Ravi Narain and former LIC chairman Thomas Mathew, also outlined the need for “substantial rethinking” on revamping financial law and regulation, and improvements in urban governance.
Drawing analogy from China’s vigorous program for internationalisation of the renminbi and for easing capital, the panel said “India should also consider such a strategy through which the Indian rupee becomes one of the important international currencies.”
Critical of a plethora of taxes, the panel said “imposition of taxes on transactions and taxes on participants in a market, adds to the transactions cost of participation in a financial system. The effect of this is similar to that of capital controls.”
The Council proposed that a modern income tax and the introduction of GST, resident-based taxation and removal of bad taxes such as stamp duties.
Urging for simplification of the tax regime, the panel cited the issue of applicability of Minimum Alternate Tax (MAT) on FPIs that arose in December 2014.
One of the most important points that the panel highlighted is the need for a Bond-Currency-Derivatives nexus for a more effective monetary policy mechanism in India. “If India is able to regain market share within the onshore market, and if the Bond-Currency-Derivatives Nexus evolves locally, the central bank will become more effective with a strong monetary policy transmission that is able to help counteract business cycle fluctuations,” it said.
If, on the other hand, the onshore financial system reduces, the central bank will find it more difficult to stabilise business cycle fluctuations, it added.
Since it will take some years for the Indian Financial Code to be enacted and enforced, the panel said a parallel strategy has been devised to improve Indian export of financial services using Finance SEZs (such as GIFT).
Pointing to a sharp rise in overseas financial activities on Indian assets, the panel said the two most visible of these are the derivatives on the rupee and the market index Nifty. “An active market for these has developed offshore. This report estimates on these two underlyings alone, trading outside India adds up to a daily turnover of just under $20 billion (out of the total market size of $63 billion.”
“This means that the end-user has a choice of where to send an order to trade the rupee or Nifty. Rupee derivatives trade in onshore Over-The-Counter (OTC) markets, onshore exchange-traded markets, offshore OTC markets, and offshore exchange-traded markets. Nifty trading is prohibited on onshore OTC markets but trade in the other three. The choice of offshore markets is available for other areas also, such as credit default swaps on Indian assets, equity and debt issuance by Indian firms, hedging of commodity risk, where global venues are becoming increasingly important,” it said.
The Committee has identified three broad sources of the problem: capital controls, mistakes in financial sector regulation and taxation. From the viewpoint of a global customer, sending an order to (say) the CME in the U.S. or the Singapore exchange (SGX) is frictionless. There are no capital controls.
Domestic financial regulation at these venues is technically sound while being friendly to the goals of international competitiveness in financial services. Both have residence-based taxation where the activities of an overseas customer are not taxed. Both the CME and the SGX trade currency contracts on the rupee and on the Nifty.
For India to compete in the new globalised world of finance, our markets must match these competitor markets in three respects: rationalise and ultimately remove capital controls, achieve technically sound financial regulation, and shift to residence-based taxation. There are many elements under these three areas that can, and need to, be addressed.
For example, a key irritant in rules on capital controls are the content of KYC requirements faced by overseas customers and the manner of their implementation.
India imposes onerous KYC rules and applies them with ambiguity, when a possible solution that makes us more internationally competitive is to match the requirements of the FATF as is done in other financial centres, it said.