In theory, theory and practice are the same; in practice, they are not—or so goes the saying. This dichotomy is starkly seen in India’s policy missteps when it comes to developing vibrant and liquid financial markets onshore.
The government’s stated policy is to curb the export of financial markets to offshore centres such as Singapore and Dubai. In fact, this was one of the reasons it promoted an international financial services centre (IFSC) in Gandhinagar. But in practice, recurring policy mistakes continue to help these offshore centres gain at the expense of onshore markets.
After handing over large chunks of the exchange-traded index futures and dollar-rupee futures markets to Singapore and Dubai, India has set things up nicely for these centres to seize a sizeable share of the single stock futures market.
News reports suggest Singapore Exchange (SGX) will soon launch futures contracts with top Indian stocks as the underlying. While there are multiple factors that will help SGX build a liquid market for single stock futures, India’s decision last July to curb participatory note (P-note) issuances has increased the viability of the product by leaps and bounds. This column pointed out last year (Who uses P-Notes anyway?) that tightening norms for P-note issuances will wrongly keep out legitimate investors who don’t want to register directly with the Securities and Exchange Board of India (Sebi).
Such investors may want to avoid the rigmarole and cost of registering with another regulator, or may have a mandate for buying only dollar denominated securities. With the P-note route more or less closed, these investors will take to the new product like a fish to water.
And that’s not all. An SGX launch can cause large trading firms to shift some of their trading activity from India, given advantages such as lower taxation and currency risk mitigation.
What is the extent of damage that is possible? A lot, if the Nifty futures contract is any indication. About 40-45% of turnover and as much as 70% of the open interest is on the SGX platform, with the remaining share with NSE.
And the fact that large trading firms are already connected to SGX means that trading single stock futures on the platform will be a breeze for them. They can potentially start diverting liquidity from India to Singapore as soon as the product lists.
Reports suggest that Indian exchange officials and some policy makers are jittery is hardly surprising. But putting diplomatic pressure on SGX to not launch the product, as a Business Standard report suggests, is bizarre.
It is high time India gets its policy priorities right. If Singapore scores high on ease of access and taxation, these are areas that policymakers must address. This column has argued that it makes more sense to promote existing markets in the mainland, rather than make room for IFSCs by doling out incentives. But ironically, even the promotion of IFSCs comes across as half-hearted. While offshore centres such as Singapore and Dubai waive short capital gains tax, IFSCs do not. It’s true that investors use the Mauritius route to avoid these taxes in the mainland, but the uncertainty about tax rules would mean that offshore centres will continue to score over India in this regard.
Besides, centres such as Singapore are easy to access and allow the use of structured products, which are an anathema for Indian policymakers. If, for instance, trading firms and institutional investors are allowed to create and trade in structured products onshore, a large part of the demand for P-notes and other related products offshore would disappear.
Ironically, with SGX and NSE, the history dates back to the year 2000, when a delay in the approval of index futures trading in India, led to the launch of Nifty futures in Singapore. NSE has licensed the use of its index to the SGX—the offshore centre’s other large index contracts involve licences with third-party index providers such as FTSE and MSCI for the China and Taiwanese markets, for instance.
From the looks of it, NSE may now well regret its decision to partner with SGX. There is also the possibility that it may plug the licensing agreement with SGX as a retaliatory measure, if the latter goes ahead with its launch of single stock futures.
But back in 2000, hardly anyone envisaged that SGX will be a threat. It was believed that its market will be restricted to investors who can’t otherwise access Indian markets.
The P-note ban in 2007 coupled with other policy decisions such as the imposition of securities transaction tax have increased the clout of SGX. In 2007, its share of total open interest in the Nifty futures product was just 6-7%, according to data collated by Edelweiss Securities Ltd. This has now risen to as much as 70%. Put differently, its open interest of $8.4 billion is more than double that of NSE’s.
Ironically, it was around the same time—in 2007—that the ministry of finance received an expert committee’s report on making Mumbai an international finance centre. The committee provided a number of recommendations on how India can rise in the area of exporting financial services to the rest of the world. Instead, since then, it has rapidly exported large chunks of its existing markets. The policy missteps are not restricted to equities. Both over-the-counter and exchange-traded markets for the dollar-rupee have gradually moved offshore. Dubai and Singapore together accounted for 47% of exchange-traded turnover in the contract in December and as much as 66% of open interest. In the over-the-counter forex derivatives market, a Bank for International Settlements’ (BIS) triennial survey of central bank revealed that only 41% of trading, in turnover terms, happens onshore.
It’s time policymakers moved beyond half-hearted measures to arrest this decline across different market segments.