Bombay Plan 2007

How should India globalise? Pick politically feasible bits of a fine study on liberal finance

The Bombay Plan of 1944 was a milestone in India8217;s economic policy thinking: it laid down the blueprint for how India must industrialise. The 8216;Mumbai International Financial Centre8217; MIFC report is 8216;Bombay Plan II8217;, a comparable blueprint for how India must globalise. It is the first coherent and intellectually consistent set of ideas for how fiscal, financial and monetary policy need to change, for harnessing the opportunities and facing the threats of globalisation. The implementation of this report over coming years will be a key element of India8217;s strategy for accelerating growth.

MIFC is superficially about achieving huge exports of financial services. But it runs much deeper. Export-orientation will require achieving competition and efficiency in finance, exactly as export orientation gave us competition and efficiency in the real economy. As Raghuram Rajan has emphasised, a better financial sector improves entry and competition in the economy. Improvements in the quality of finance give us better bang-for-the-buck in converting investment into GDP growth. As example, the US has an ICOR incremental capital output ratio of 5-7, while Germany and Japan have ICORs of 12-15. This difference is partly about the remarkable US financial system. The MIFC report gives us a game plan for obtaining a world class, globally competitive financial system. This is useful because we make money on exporting financial services. But the real importance lies in accelerating GDP growth. In my view, the implementation of this report alone will add roughly 2 percentage points to India8217;s growth.

The report is on the right track on fiscal questions. Unlike many lobbying efforts, the report asks for no special tax breaks or setting up a tax-exempt enclave. It emphasises sound principles: bring down the debt/ GDP ratio, not tax exports, and integrate finance into the GST.

Recently, India has been experiencing difficulties in monetary policy. These difficulties point to deeper flaws in the monetary policy regime, and lend urgency to monetary policy reform. The MIFC report has the correct answer, in proposing an Indian Monetary Authority which is independent, transparent, focused and accountable. Inflation underlies the bond market and the bond market underlies all finance. An inflation targeting central bank stabilises inflation, and thus stabilises the bond market and all finance. Inflation targeting will provide the necessary anchor for stabilising India8217;s macroeconomy in an age of globalisation.

Many details remain to be worked out. How should inflation be measured? What is the analytical and operating framework for inflation targeting? The intellectual firepower for solving these questions is available and these details can be addressed. The big picture proposed in the MIFC report is the right one. The government should endorse this direction, and get going on solving these questions of detail.

How will the report get implemented? Suresh Tendulkar8217;s recent book on the political economy of reforms suggests that a consensus-driven incremental approach may have to be taken. The broad policy community will absorb the ideas of the book, and chip away at implementing them on a hundred fronts. India has proven ability to initiate policy processes to achieve far-reaching change 8212; as was seen with public finance in the last 15 years. Such far-reaching change now needs to be brought about in financial and monetary policies.

A specific checklist of what is politically feasible today is: The Bond-Currency-Derivatives Nexus has been rightly emphasised by the book as the big missing link in Indian finance. The actions recommended in the report are entirely feasible. No further committees are required, and Parliament will support any work allocation between regulators that is proposed by the ministry of finance. In particular, the rupee-settled currency futures market needs to start immediately, to help firms cope with the micro effects of currency flexibility.

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Rupee denominated bonds 8212; both government and corporate 8212; can be immediately placed on a par with equity in our treatment of FIIs. This is a critical element of the MIFC agenda, and one that benefits India in any case, by easing public debt management and enhancing bond market access for medium-sized firms. It is an urgent requirement because it will reduce the extent of foreign currency borrowing and, hence, currency mismatch, which is now taking place with firms.

Greater entry for private banks, and the elimination of branch licensing requirements, can immediately improve competition in banking. This is feasible immediately. The integration of finance into the GST is a key piece of the puzzle. The government needs to appoint a committee with experts like Amaresh Bagchi and Satya Poddar, along with practitioners in international finance, in order to plan out the mechanics. More generally, this committee should be tasked with identifying and eliminating harmful aspects of taxation which impede export-oriented financial services production based on the core principle of 8220;you do not tax foreign consumers8221;.

An expert committee needs to be set up to redesign the RBI, to draft the legislation governing the Indian Monetary Authority, and to design the analytical and operational framework through which an IMA will achieve inflation targeting on a day-to-day basis.

One big milestone in the removal of conflicts of interest is the decision announced in the 2007 budget speech, to set up the Debt Management Office. It is now time to resurrect G.V. Ramakrishna8217;s idea of a National Shareholding Trust in order to perform ownership and governance functions for PSU banks, so as to remove the conflict of interest of bank ownership away from both RBI and ministry of finance.

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The ministry needs to initiate technical work on redrafting financial legislation, with a focus on the Financial Services Modernisation Act envisaged in the MIFC report.

Convertibility in 18-24 months appears daunting, but there is ample avenue for incremental progress. In parallel, an expert committee needs to be set up to draft the replacement of FEMA and to fully work out the institutional nuts and bolts of convertibility.

In summary, the MIFC report is the game plan for India8217;s globalisation. Every element of this report is required to accelerate growth. It is time for us to do for finance what was done, with great success, for the product markets.

The writer headed the task force on tax reforms and is chairman, India Development Foundation. This article is based on his comments at the CII conference in Mumbai on the Percy Mistry committee report