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Friday, February 09, 2018

Hollowing out of India's financial markets: Banning trading abroad is not a choice

by Ajay Shah.

For a long time, there has been a realisation that India's policy mistakes on capital controls, financial regulation and taxation will induce a hollowing out of Indian financial markets. Here is an example from May 2012. The two most important products are Nifty and the rupee, and these are increasingly dominated by overseas activity. Non-residents have a clear choice about where they wish to send their order flow and locals also are known to evade capital controls and take their custom to more competitive venues. In this week, there is an amplified concern about these problems e.g. see Mobis Philipose in the Mint and my article in the Business Standard.

These developments are good for the real economy, as superior mechanisms of financial intermediation are displacing the inefficiencies of the onshore financial system. This reduces the cost of doing business for foreign investors.

But at the same time, we in India are losing massive financial service exports as the business is shifting out of India. On the rupee, the estimated loss of revenue for India is around Rs.60,000 crore per year. Similar values are likely to prevail for Nifty.

In many developing countries, the lack of macro/finance policy capabilities gave a comprehensive hollowing out of domestic financial markets. This is the scenario that is being posed before India. 

The correct solution to this problem lies in going to the root cause, and solving our mistakes of financial regulation, capital controls and taxation. This  painstaking work has been analysed in by the Standing Council on the International Competitiveness of the Indian financial sector, which was setup by the Department of Economic Affairs in June 2013 in recognition of this problem.

Men and nations will do the right thing after trying every reasonable alternative. What are these `reasonable' alternatives?

Ban the product

I remember a time when RBI requested the UAE central bank to force DGCX to not trade INR futures. Such a ban is not in the interests of either DGCX or the UAE, and this request was not accepted.

Block the participants

RBI has tried to say to international firms operating in India: do not trade in India-related financial markets overseas. But the jurisdiction of RBI is limited. There are concerns about non-rule-of-law methods of harming firms who do not obey.  RBI and SEBI periodically try to ban PN trading.

These bans are futile as India's regulators have no ability to enforce these bans. In any case, even if the ban is effective, all that will happen is that the business will move from firms that comply with India's grab for extra-territorial jurisdiction to firms that do not care about  India's regulators.

Block the information products

Nifty is made by IISL, which is  an India-domiciled information company.

IISL is not a financial firm and is not exposed  to RBI or SEBI regulation. But perhaps non-rule-of-law techniques of coercion can be applied. Suppose  this succeeds, and IISL does not license Nifty to SGX.

SGX has numerous alternatives. SGX can go to a mom-and-pop index provider who makes a Nifty-like index: an index where 49 of  the 50 stocks are the same as those in Nifty. SGX can shift to the MSCI India index, and MSCI can gently move closer  to the Nifty composition.

If, somehow, SGX is prevented from having an effective exchange-traded Nifty product, the business will just go OTC.


Let's not lose sight of what is going on. There is a trading venue that offers lower costs in investing/trading on Indian assets. We are discussing tools for protectionism through which the cost of participating in the Indian economy is driven up. This is not in India's interests.

Our course of action should lie in solving the Indian policy mistakes of capital controls, financial regulation and taxation.


  1. Something that irks me more than the various bans, duties, etc themselves is that it de facto applies only to the common people. The rich have their ways around the bans. They travel around so they don't pay duties and they can have shell companies so they can do personal stuff under the guise of corporate accounts and so on....

  2. News reports inform that the Indian exchanges have collectively decide not to license their IP (ie Indices) to overseas exchanges. This will only encourage the overseas exchanges such as the SGX to (1) launch single stock future (as SGX recently has) and (2) develop their own indices. Both of these would hurt the revenues of Indian exchanges

  3. It appears someone read your blog.

  4. It is unclear how single stock futures will be exempted from this "prohibition". The press release declares that Indian exchanges will not share any data for trading or settling derivatives in any form. It is not restricted to indices alone.


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