Mumbai SAR, International Capital Market Centre

Back in August 2008, even before Lehman Brothers collapsed, it was already time to think of the shift of the global intellectual capital from the West to the East. The West had failed in specialising exclusively in services and that too, in financial services. There was no ‘dark matter’.

Hence, renewing the push towards the goal of making Mumbai an international financial centre (IFC) should be viewed in this broader framework rather than be seen as the creation of an offshore financial centre in India that conjures up thoughts of money-laundering, soft-touch regulation and tax arbitrage.

What Mumbai should aspire to be is not so much to be a IFC, but to be a ICMC—an international capital market centre like London, New York and Tokyo. An ICMC is one where foreign companies come to raise money and list their shares, talent comes to live and the centre acts as an intermediary for efficient capital allocation within and across sectors and nations.

It would be narrow also to view the recent travails of Dubai as an opportunity for Mumbai. By its very nature, Dubai could have only aspired to be a regional financial and trading hub. Mumbai—and India in general—should set its sights higher. Nonetheless, there are lessons in the present set of circumstances facing Dubai.

Lessons from Dubai

First, the development of a financial centre could lead to over-reliance on the  financial sector to drive economic activity at the expense of other drivers. Second, the copious amounts of capital flows that international financial centres receive from time to time could lead to to over-investment, excess capacity, indigestion and repayment problems. Dubai had no dearth of money to finance its ambitious construction projects, yet came close to defaulting on its obligations to its creditors.

Third, the evolution of a financial centre should go hand-in-hand with the evolution of the state and society which it is a part of. Openness, transparency, rule of law, independent checks and balances such as accounting, auditing and credit-rating agencies should be functional. Beyond these, the financial centre should evolve as a living and thriving organism, a place suffused with culture and history, to which human beings naturally gravitate to, to live and raise their children. An influx of people temporarily lured by material prospects is not a sustainable proposition for the long term.

Lessons from New York and London

In addition to the above factors that were partly responsible for the sudden rise and the recent loss of halo for Dubai, India has to absorb lessons from New York and London. Although these centres and their financial markets have gone through highs and lows, no upheaval has been as big as the one that they went through in 2008. That has been the culmination of the over-reliance on financial capitalism as opposed to ‘just’ (pun intended) capitalism.

Finance came to dominate economic activity and economic policy-making to the near-total eclipse of all other activities such as manufacturing and other services. Young people concentrated on acquiring degrees that would fetch them employment in financial services. Compensation rose since profits rose with the concentration of human, policy and regulatory firepower in the sector. That further increased the influx of talent into this sector.

As Raghuram Rajan, a professor of finance at the University of Chicago has observed, the financial crisis has shown that developed countries also do not have any special skills in managing specialisation in services. We must recall the observation of Y V Reddy, former RBI governor, that India has one of the world’s most balanced economies in the world today. Hence, there is little immediate danger that the Indian economy will similarly come to be dominated exclusively by financial services and related activities as it happened in the developed world in the last quarter century.

What a international capital market centre is not

International tax arbitrage and light-touch regulation are not the cornerstones of an international capital market centre. They might be for smaller centres that have little else to offer. India need not follow that path. It is important to realise that major international capital market centres evolved and reached their pinnacle well before they became hostage to the intellectual discourse of light-touch regulation. That is one more reason a international capital market centre rather than an international financial centre is a better term to describe the goal Mumbai should move towards. The former puts finance in its rightful context—as an instrument to direct capital to creditworthy sectors—while the latter brings forth images of money-laundering, tax evasion and sheltering of criminals.

Two questions arise: First, are the existing centres—mainly New York and London—permanently damaged? Second, what are the obstacles that hobble Mumbai’s quest to become an international capital market centre?

Mumbai’s obstacles

Nothing consigns New York and London to a permanent dustbin as far as capital market activity is concerned. They can, however, certainly do with some competition from Mumbai. More importantly, private sector savings in the United States and Britain are likely to be increasingly appropriated by their governments. According to the Financial Times financial sector losses in the current crisis have totalled $2.6 trillion whereas bond issuance by G-10 governments totalled $12 trillion in 2009. In other words, there is no private saving left for these capital market centres to intermediate. This will remain the case for quite some time.

The major issue confronting Mumbai, however, is that India suffers from the same malady. The savings of the household sector are appropriated by the government through banks. This compels India to maintain a high Statutory Liquidity Ratio with banks absorbing the bulk of government borrowings. In such a situation, throwing open the bond market to foreigners will only cause huge swings in the prices of Indian government debt, leaving Indian banks to face the consequences of such swings. Their balance-sheets could be imperilled.

Therefore, the best preparation that the Indian government can do—besides announcing its intention and time-frame to develop Mumbai into an international capital market centre—is to rein in the fiscal deficit and set it on a sustainable course. A country with so much dynamism in the non-state sector does not need a bloated state that sucks resources away from productive applications. The availability of savings for local and international companies to tap into is an essential prerequisite for India to host an international capital market centre on its shores.

Indeed, reformers fond of seeing a so-called market-based financial sector would do well to train their guns consistently on the government. Without both a quantitative and qualitative improvement in government finances and expenditure, India’s aspirations to become a global power will remain just that.

What of Mumbai itself? Its infrastructure and traffic nightmares are legendary. One way to fix them is to announce that Mumbai, like Hong Kong, will become a special administrative region within the country and to place it under a separate technocratic administration. Over time, Mumbai SAR can surely take on Hong Kong SAR and much more.

Why does it matter?

It is important to recognise the roles that New York and London played—through their dominance of international capital markets—in the ascent of the United States and Britain as the world’s great powers. They brought forth immigration, cultural influences, confluence of talent and employment opportunities (in the real and the financial sectors, nationally and globally) for the local populations.

In a recent speech in Singapore, Dr Reddy pointed out that while the momentum of economic activity might be shifting eastward, the intellectual discourse on international capital markets is still dominated by and takes place in the West. He cited the dominance of Western television networks, newswire services and credit-rating agencies as examples. Indians, he argued, with their command over English, their presence in Western academia and industry, and their familiarity with Western legal systems could help to complete the shift of economic momentum eastward by complementing it with a shift in intellectual momentum too.

Realising an aspiration of this scale and ambition is neither easy nor quick. That is precisely the reason why it brooks no delay. A grand announcement by the Indian government will galvanise the nation into prioritising the other missing links such as a liberal education sector, an accent on quality higher education, healthcare and competent urban management.

There is, in addition, a geopolitical angle to the project of developing Mumbai into an international capital market centre. It would send a signal to the rest of the world that India has begun to take itself seriously.