The Mistry report mystery

Financial Express, 29 June 2007

The Percy Mistry Committee Report on making Mumbai an International Financial sector recommends far reaching changes in India's financial governance. Not surprisingly, while at least half the commentators on the report have said that the government must go ahead and implement the recommendations as soon as possible, others have said that the recommendations of the report are a pie in the sky and cannot be implemented.

It is true that today there is very little awareness about interntional financial services. International financial services (IFS) refer to cross border services that deal with the flow of finance and financial products such as raising of funds such as debt and equity, risk management, asset management such as that done by insurance companies, mutual funds and pension funds, corporate treasury management operations and highly developed derivatives among others. The situation is not unlike what was true many years ago for IT and BPO. Perhaps only companies such as TCS and Infosys engaged in these sectors understood this and played this game. But regulatory changes in the telecom sector were an essential input into the process that has made India a global leader in this sector. In a similar fashion, the companies in the Indian financial sector foresee that India has a natural advantage in the sphere of international financial services and that could bigger a big money spinner for them and India. However, the current structure of financial governance is an obstacle in their way. The recommendations of the report primarily seek to set right India's financial governance which prevents international financial services from being producted in India for either foreign or domestic consumption. They relate mainly to changes in financial markets and their regulation so that Indian companies do not have to turn to London or New York for buying IFS.

So why is a country that usually clamours for import subsitution and export promotion wary about this report? Because while the report is ostensibly about producing IFS, it has far reaching implications about they way we have organised our financial sector. It recommends doing away with the licence permit raj in finance and opening Indian finance up to the world of scary high finance with electronic and computer run trading. Interestingly, it appears that Indian finance companies are not afraid of these challanges and are, in fact, asking to be allowed a piece of this pie. Today they are regulated out of this world of high finance. Government policy, instead of giving domestic firms protection, is preventing them from competing with global financial firms.

There could be a number of reasons why recommendations of the Percy Mistry report may not be implemented. The most important of these is political economy. When Jagdish Bhagwati recommended trade liberalisation in India in the 1960s there were interest groups that benefited from protection and did not want liberalisation. It did not matter whether it was good for the country or not. Domestic firms were happy behind the walls of protection. They had economic and political clout. Infant industries long outlived their infancy, yet tariffs were not brought down. Even until today a reduction in tariffs is met by some cries of protest.

Had the MIFC report had been signed by a bunch of academic economists, one could have started discussing whether they had recommended a first best solution, as should be the job of economists, and why the real world is not going to like it. It is striking that the report has been signed by the Who's Who of Indian finance. Practitioners are not known for making academic points. The wish list of practitioners is usually one that can be implemented. They do not usually waste their time chasing dreams. So, if the Who's Who of Indian finance supports the recommendations, who opposes it? Who is the loser? What is the political economy of the opposition to MIFC?

Is it Indian industry? Indian companies are unable to buy international financial services(IFS) in India where they would likely have been cheaper and more efficient for them. Why should Indian firms choose to buy IFS from London or New York? Why should Indian firms have to hedge their currency exposure in Singapore or Dubai? Considering the pace at which the demand for IFC is increasing it has been projected that by year 2015 the demand for IFC by Indian companies will be USD 50 billion. It does not seem that Indian industry will oppose the recommendations of the report.

If Indian manufacturing companies and Indian finance companies gain, where is the interest group that would prevent the implementation of the recommendations? Who are the counterparts of the US blue collar worker unions opposing tariff reductions and Japanese cars in the sixites or of US white collar workers opposing outsourcing to India more recently. In fact, if there are losers they are the competing international financial centres. So Shanghai and Dubai might try to find friends in India who would raise a hue and cry and do some fear mongering to keep Mumbai from outcompeting them. The fear of capital account convertibility may be a useful instrument in this game.

Another reason why the recommendations may not be implemented may be bureaucratic hurdles. It is interesting that hardly anyone is saying that the recommendations should not be implemented, or that it is not a win-win, or is identifying a set of losers. Instead commentators seem to be saying that it is too much to ask.

Finally, there is a question of consensus on the speed with which India needs to move towards capital account convertibility. Differences on this issue underlie the approach different commentators take towards the MIFC question. As India globalises at a growing pace, there is likely to be greater consensus on convertibility. In the meanwhile, the government needs to prepare better for the making the path to convertibility as smooth as possible. Whether it happens sooner or later it is merely a question of time. No one really believes that India can go back to being a closed economy again.

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