Creating a Hong Kong or Singapore will involve some pragmatic choices and, in the worst case, may involve sacrificing existing markets in Mumbai
This Friday, all roads will lead to Gujarat International Finance Tec-City Co. Ltd, also known as GIFT City. Finance minister Arun Jaitley will unveil rules for international financial services centres (IFSCs) at Gandhinagar on 10 April. He will be accompanied by financial regulators and top bureaucrats.
The show of strength reflects the government’s support for the project. It appears provisions of the Foreign Exchange management Act (Fema) will not apply to firms residing in the new city. Some expect Jaitley to back this up by announcing tax concessions that will apply only to firms that operate within it.
This sounds similar to the one country, two systems of China and Hong Kong, and it is. Can GIFT City be India’s Hong Kong?
The financial industry in Hong Kong has been boosted in the past few weeks after China further opened up the Shanghai-Hong Kong Stock Connect that allows investors in each of these markets to trade on the other. Inflows into Hong Kong have ballooned after mutual funds were also allowed to use the channel. If firms in India are allowed to move capital easily to and from GIFT City, the new project will get a great boost. After all, which Indian financial firm wouldn’t want to take advantage of the tax and other concessions on offer?
However, the government doesn’t seem to take this approach. Based on the guidelines the Securities and Exchange Board of India (Sebi) and the Reserve Bank of India (RBI) have released, the same Fema restrictions will apply on Indian residents with regards to their transactions in GIFT City as in any other overseas jurisdiction. All financial transactions in GIFT City will be in non-rupee denominated securities.
Why even raise the question then? This is because Indian firms will be the most natural participants in the GIFT City story, although the idea was mooted originally to attract overseas participants. If financial services in the new city don’t pick up, there will always be the temptation to ease restrictions to attract participants, which could perhaps result in a window opening for Indian firms and individuals to participate more freely than they are currently permitted.
As things stand, building a robust market mainly from participation by global firms looks like an uphill task. Take for instance the dollar-rupee futures market. Officials from GIFT City have often said India’s loss of market share in this product can be won back with its launch of a dollar-settled version of it.
The central bank has been wary of the development of exchange-traded currency markets. Indian firms who were using overseas exchange-traded currency markets are known to have been told off by the central bank, and Financial Technologies (India) Ltd had been forced to reduce its stake in a Dubai exchange offering a dollar-rupee futures contract.
Given the central bank’s unease, global firms may prefer to take their orders to overseas destinations, including the fairly liquid non-deliverable forwards market.
Likewise, one of the main reasons global investors love using participatory notes is that it allows them to enter into customised over-the-counter (OTC) derivatives contracts with overseas brokerages. Sebi’s IFSC guidelines are silent on whether OTC derivatives will be permitted. It’s presumed that provisions of the Securities Contracts (Regulation) Act will apply, unless there are specific exemptions for IFSCs, thereby meaning that financial firms may still be unable to offer products they can’t offer in the main shore markets.
In order to attract financial market professionals to set up base in the new city, the government will need to provide not only concessions, but also freedom in areas such as product innovations, just as they are used to in international markets. Besides, the new jurisdiction must also have a robust legal system.
This is not to dismiss the potential of a well-managed IFSC. However, creating a Hong Kong or Singapore will involve some pragmatic choices and, in the worst case, may involve sacrificing existing markets in Mumbai.