While it’s true that Singapore Exchange has garnered a high share in one product category involving Indian equities, India’s own equity derivatives turnover has also grown at a fast pace.
A national disaster has been averted, we are told. Liquidity was migrating from India’s equity markets to offshore centres such as Singapore, and nothing short of a coordinated ban by all Indian exchanges was needed to stem the tide. Whatever the underlying reasons for this extreme step, the move will deal a body blow to India’s equity markets. It’s an own goal of sorts.
First, claims about migration of liquidity are a bit exaggerated, which raises questions about India’s capacity for evidence-based policymaking. While it’s true that Singapore Exchange (SGX) has garnered a high share in one product category involving Indian equities, India’s own equity derivatives turnover has also grown at a fast pace. In the past 10 years, average daily turnover on NSE has multiplied 12-fold to over $100 billion. Less than 3% of this comes from the Nifty futures contract, in which SGX has an almost equal share of trading.
Sure, Singapore’s high share in Nifty futures trading is a cause for concern, and has been highlighted in this column in the past. But the learning, if anything, was that some investors were staying away from India’s financial markets because of high transaction taxes and haphazard regulatory actions. For instance, traders largely congregate around the index options market in India, where transaction costs are relatively much lower.
The policy stance should be to take corrective steps and remove these inefficiencies. Instead, policymakers have chosen to shut out competition. “By blocking competition, India’s financial markets are being set up for greater inefficiencies. They can get progressively worse on services and costs, without a check from credible competition,” says an expert on market structure who asked not to be named.
In an essay titled Indian Economic Planning, Milton Friedman, a Nobel laureate in economics, had pointed out the high level of inefficiencies that came out of the country’s decision to ban imports of automobiles with a view to save foreign exchange. “New automobiles, copies of foreign makes, are being produced at a very high cost in small runs under extremely uneconomic conditions at four different plants in India. These are available by one channel or another for the “luxury” consumption it is said to be desirable to suppress. Many of their components are imported, and many of those made in India use indirectly imported materials. The result is that not only is the total cost of the amount of motor transportation actually produced multiplied manifold, but even the foreign exchange cost is probably larger,” he wrote in the 1963 essay. He also spoke of a used car he sold for $22 before leaving the US, a new version of which was being sold for as high as $1,500 in India.
Friedman’s anecdote also points to the fact that people find ways around bans and controls, and these typically involve far higher costs, which the entire economy has to bear. The market structure expert also wonders about the applicability of anti-competition law, since the ban effectively makes NSE a monopoly in the market for derivatives with Indian equity indices as the underlying.
By blocking out competition from overseas exchanges, India is almost saying that foreign capital is only welcome if investors bother making their purchases on Indian shores. This will shut out investors who have legitimate reasons for using other structures for exposure to India. A committee appointed by the finance ministry and headed by M.S. Sahoo understood this well and recommended even unsponsored depository receipts, so that the friction that keeps away some of the overseas capital from Indian markets is taken away. Sebi has ensured this product hasn’t taken off yet.
Similar fears are behind the ban on P-notes and now index derivatives trading by overseas exchanges. By shutting out these sources of capital, companies looking to raise funds will be hurt in terms of higher cost of capital.
Perhaps, some of us are being too cynical. What about the solution called Gift City that Indian policymakers have come up with for all of these problems? “Overseas investors needn’t think they are shut out; they are welcome to the international financial service centre in Gift City” we are told. But in doing so, India may be setting itself up for a new set of problems down the road. Just think about it: Which major economy that has a large-sized market of its own has created and promoted an offshore centre within its jurisdiction? Most offshore centres have come up in places such as Singapore and Dubai, which don’t have large domestic markets, and largely exist as a gateway to markets outside of their jurisdiction.
By promoting an offshore centre within the country, and now banning overseas exchanges from trading Indian equities, it’s a no-brainer that Gift City can end up cannibalising existing markets in Mumbai. If liquidity picks up to meaningful levels at Gift City, Indian trading firms may well migrate to take advantage of the tax sops in the offshore centre. Policymakers should worry about that sort of migration and fragmentation of liquidity more.
The Securities and Exchange Board of India was part of the discussions which eventually led to the ban announced by exchanges . The regulator would do well to present its views on these market structure matters with adequate data and evidence; else, as some foreign investors are reportedly saying, it wouldn’t be unfair to conclude that India’s financial markets policy making process is haphazard.
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