It’s not a great time to talk about reforms in India’s financial markets. With many financial markets in developed countries in turmoil, some experts are even lauding the Indian stance of going slow on market reform. But such arguments conveniently ignore the fact that going slow on market reforms has its own costs.
India is said to have a well- functioning market only in the equities space, that too only for the top 200-or-so stocks and Nifty futures and options. The corporate bond market is almost non-existent, and all other markets are inefficient in some form or the other.
This inefficiency results in added costs to users of these markets, which in turn hurts the economy. In some cases, users simply access overseas markets because of the inefficiency of the onshore market. This again has a cost for the Indian economy. One example of this is the use of overseas commodity exchanges by large Indian companies.
The ban on the participation of institutional investors in commodity exchanges has made these markets shallow and unviable for large companies to hedge their exposure. The smug feeling that going slow on market reform has helped the country will result in a status quo for some time to come, which unfortunately means that the Indian economy will continue to bear these unnecessary costs for a long time.
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Also, it’s important to note that large financial exchanges in Chicago and London continue to operate smoothly and haven’t seen any disruption in operations. It’s the banking industry, which gave out risky loans, that’s at the centre of the global financial crisis. True, some financial markets failed as well, such as the market for credit default swaps. But again, many of these markets were dominated by banks. The financial markets that functioned with appropriate regulation and with participation from a wide set of investors have come out unscathed. Opaque markets, especially those run and used primarily by banks, have floundered.
In an Indian context, contrast the transparency of the currency futures market with the opaqueness of the OTC (over-the-counter) market for currency derivatives run by banks. Those who support a status quo essentially suggest that such markets should remain the domain of banks and participation in currency futures should be restricted. Indeed, the market is still closed to a number of participants. It’s surprising to take such a stand considering that the controversy relating to OTC forex derivatives didn’t happen too long ago.
If anything, attempts should be made to encourage more transparency and wider participation so that markets become more efficient. This is not to say that there is no place for the OTC market. But one can’t pretend that these markets have no problems and that necessary precautions should be taken only for the exchange-traded product, since it has been newly introduced.
Also, while financial market reform may sound scary to some at present, many of the recommendations of the Percy Mistry committee and the Raghuram Rajan committee are for products and markets that are far from exotic. These include basic markets such as commodity options, currency options and interest rate futures and options. All these can trade on an exchange platform, containing risk thanks to the central clearing house. No one is recommending exotic derivatives at this point. India is currently almost at the other end of the spectrum with respect to financial innovation. Moving forward will involve little risk.
Of course, with elections around the corner, it’s unreasonable to expect new product introduction or any change in market infrastructure. But this time can be used as an opportunity to learn the right lessons from the financial crisis.
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