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  • 1. Report of the High Powered Expert Committee onMaking Mumbai an International Financial Centre
  • 2. Report of the High Powered Expert Committee onMaking Mumbai an International Financial Centre Ministry of Finance Government of India New Delhi 
  • 3. Report of the High Powered Expert Committee onMaking Mumbai an International Financial CentreMinistry of Finance, Government of India, New DelhiThis work consists of a printed book and release of its contents in PDF format in the world wide web, and are subjectto copyright. All rights are reserved, whether whole or in part of the material is concerned, specifically the rights oftranslation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on CDROM or in any other way, andstorage in data banks. Duplication of this publication or parts thereof is permitted only under the provisions of theIndian Copyright Act in its current version, and permission for use must always be obtained from Ministry of Finance,Government of India, New Delhi.Published by Sage India, B-1/I-1, Mohan Cooperative Industrial Area, Mathura Road, New Delhi 110044, India.Ministry of Finance or Sage India make no warranty of representation, either express or implied with respect to thiswork, including their quality, merchantability, or fitness for a particular purpose. In no event will Min. of Finance orSage India be liable for direct, indirect, special, incidental, or conseqential damages arising out of the use or inability touse the work, even if Min. of Finance or Sage India have been advised of the possibility of such damages.The use of general descriptive names, registered names, trademarks, etc., in this publication does not imply, even inthe absence of specific statement, that such names are exempt from the relevant protective laws and regulations andtherefore free for general use.c Ministry of Finance, Government of India, 2007.Printed in India byTypeset using PDFTEX and GNU/Linux operating system by River Valley Technologies, Trivandrum, India, The main text font used is Minion and Frutiger for floats and headings.The TEX packages used for typesetting this book have been released under General Public Licence for free usage,modification and redistribution and are available at
  • 4. The High Powered Expert Committee ( HPEC ) on Making Mumbai an International Financial CentreThe Hon. P. Chidambaram th February Minister of Finance, Ministry of FinanceGovernment of India, North BlockNew Delhi Dear Honourable Minister:We submit herewith the ’s Report on Making Mumbai an International Financial Centre.Our choice of the term ‘International’ instead of ‘Regional’ has been explained in our report. Yours sincerely,M. Balachandran O. P. BhattC. B. Bhave Bharat DoshiK. V. Kamath Nimesh KampaniK. P. Krishnan (Convenor) Subodh KumarRavi Narain Ms. Usha NarayananP. J. Nayak Aditya PuriN. Mohan Raj T. T. Srinivasaraghavan
  • 5. AcknowledgementsHPEC would like to place on record its grateful thanks to Ajay Shah, Kshama Fernandes,Saugata Bhattacharya, Ritu Anand, and S. Ravindranath who constituted the Research Teamthat supported the Committee. The  also wishes to express its appreciation to Mr. M. Balachandran who putthe facilities of the Bank of India at the disposal of the Committee. The  and theGovernment of India would like to acknowledge their appreciation to the Bank of India formeeting the administrative expenditure for the production of this report.
  • 6. ContentsExecutive Summary xiii . International Financial Services () and Centres (s) in Perspective, xiii.—. Implications for India and Mumbai, xiv.—. The difference between  and  , xv.—. What are International Financial Centres (s) and Services ()?, xvi.—. Growth and globalisation drive India’s demand for , xviii.—. India’s competitive advantages in creating an , xix.—. Financial regime governance: policy and regulation, xx.—. Reorienting the financial system towards  provision: A temporal roadmap for reform, xxiv.—. Urban infrastructure and governance in Mumbai, xxviii.—. The choice, xxx.. The Emergence of IFCs: A brief history  . Meeting cross-border trade, investment and other needs, .—. Evolution of international financial services () and centres (s), .—. The first round of globalisation: circa –, .—. An interregnum, the second round of globalisation (–), and beyond, .—. The ‘take-off ’ of second round globalisation after , .—. Classification of s, .—. Why did Tokyo and Frankfurt not emerge as credible s?, .—. The Race to establish more s around the world, .—. Implications for India and need for Mumbai to emerge as an , .. st Century IFS provided by IFCs  . Fund Raising in s: What is involved? Who does it and how?, .—. Asset management and global portfolio diversification, .—. Personal wealth management, .—. Global transfer pricing, .—. Global tax management and cross-border tax optimization, .—. Global/regional corporate treasury management, .—. Global and regional risk management and insurance/re- insurance operations, .—. Global/Regional exchange trading of securities, commodities and derivatives in financial instruments and indices in commodities, .—. Financial engineering and architecture for large complex projects, .—. Cross-border mergers and acquisitions (M&A), .—. Financing for public-private partnerships (), .. Case studies: London, New York, Singapore, Dubai  . Summary overview, .—. A closer look at the City of London, .—. New York/Chicago as the GFC for the Americas and the World, .—. Singapore as the /Asian GFC, .—. Dubai as a RFC for the Middle East and South Asia, .. Domestic and Offshore demand for International Financial Services (IFS) in India  . Implications of a large, rapidly growing home market for IFS, .—. India’s growing integration with the world, .—. The impact of globalisation on  demand and on  s, .—. Estimates for  consumption by India, .—. Projections for  consumption by India, .—. Implications for India’s aspirations to create an  in Mumbai, .—.  customers outside India as a market for an  in Mumbai, .—. International comparisons, .. Augmenting IFS provision via BPO  . How does an  produce  ?, .—. An outsourcing approach to  provision and IFC development: Possibilities, opportunities and pitfalls, .—. A  opportunity: Asset management in Mumbai based on algorithmic trading, .—. IFS subcomponents amenable to outsourcing, .—. Making progress along two paths:  Evolution and  , .—. Conclusion, .. Market deficiencies in Mumbai that inhibit the provision of IFS  . The context in which Mumbai must develop and evolve as an , .—. Inadequate currency and bond markets ( Nexus), .—. Missing currency & derivatives markets: An illustration, .—. The market weakness of institutional investors, .—. A cross-country comparison, .
  • 7. x R      M  I F C . The macroeconomic fallout of an IFC  . Introduction, .—. Implications for fiscal policy & deficit reduction, .—. Financing public debt differently, .—. The mutuality of interests in modernising debt management and having an , .—. Implications for monetary policy, .—. Outlook for the current account deficit, .—. Macro-stability for an , .—. The incompatibility of capital controls in a st century , .—. Full capital convertibility and an  in Mumbai, . . Financial Regime Governance: Its role in an IFC and a comparative perspective  . The intrinsic value of regulation for  production, .—. Three levels of international competition on regulation and law, .—. Where does India stand? An illustrative bird’s eye view, .—. The overall legal regime governing finance, .—. Summary of cross-country comparisons, . . What are the limitations of financial regime governance?  . Where do we stand? An  – Market × Players matrix, .—. A pragmatic view of key areas for progress, .—. Lessons from applying competition policy in the real economy, .—. Artificial segmentation of the financial services industry, .—. Barriers to financial innovation, . . Why does financial regime governance have these limitations?  . Why is the pace of financial innovation slow?, .—. Proximate underlying reasons that are not as transparent, .—. Deeper sources of dysfunction, .—. What impedes Mumbai from becoming an ? A summary, . . Reforming financial regime governance  . A shift toward principles-based regulation, .—. Reducing the artificial segmentation of financial firms, products, services and markets, .—. Creating an environment conducive to exit, .—. Retail vs. wholesale markets, .—. The role of exchange-traded vs. OTC derivatives in the BCD nexus, .—. Regulatory impact assessments, .—. Strengthening the legal system supporting an , . . Tax policy for an IFC in Mumbai  . Does India need an IFC or a Tax Haven?, .—. Tax policy for Mumbai as an  : and, by implication, for India, .—. A modern income tax, .—. Taxation of financial transactions, .—. A Goods and Services Tax (GST) in Finance, .—. Mumbai as an IFC: Tax Implications for Maharashtra and Mumbai, .—. Interfacing tax policy and administration with the financial industry, .—. Stability of tax policy, .—. Where India Stands on taxes: An international comparison, . . A perspective on Mumbai’s strengths  . Human capital needs for , .—. Democracy, Rule-of-Law and the Legal System, . . Urban infrastructure and governance  . The importance of high quality urban infrastructure for an IFC, .—. Problems of cost, .—. Cross-country comparison, .—. Difficulties in Mumbai from an  perspective, .—. Improving urban governance in Mumbai, . . The HPEC’s recommendations  . The general macroeconomic environment, .—. Further Financial System Liberalisation and Reform, .—. The challenge of urban infrastructure and governance in Mumbai, . Selected Bibliography  A. The Committee  B. Comparing existing IFCs against Mumbai 
  • 8. Contents xiC. Comparing emerging IFCs against Mumbai D. Chronology of events associated with the effort by Benchmark Asset Management Company (BAMC) to start an Exchange Traded Fund (ETF) on Gold E. Activities of various financial firms in the areas of operation at an IFC: Wall chart  . Fund raising, .—. Asset management, .—. Personal wealth management, .—. Global tax management, .—. Risk management, .—. Financial markets, .—. Securities markets, .—. Mergers and aquisitions, .—. Leasing and Structured finance, .—. Project financing, .—.  Financing, .—. Insurance and reinsurance, .F. Abbreviations 
  • 9. Executive Summary1. International Financial across borders: i.e. they are international Services (IFS) and Centres financial services ( ). A cross-border market for  has existed over millennia. (IFCs) in Perspective But it has been transformed in the th andHistorically, finance has always been th centuries and grown quite differently‘international’ in character; capital has rarely and more dramatically since . It has alsobeen immobile. Money has moved freely become extremely competitive, with buyersacross borders for all of civilisation with gold and sellers around the world now having aand silver (in various weights and measures) choice of procuring  from competingbeing global currencies for millennia. But, international financial centres (s).the freedom of capital was dramatically A concrete example of procuring curtailed during the ‘Bretton Woods’ regime, from an  would be the raising ofcreated in , when capital controls were debt. If Mumbai became an  , aimposed on war-ravaged, capital-starved South African railway project could issueeconomies. With post-war recovery, that a bond there in the primary market. Itregime broke down in . World finance would wish to do so because of Mumbai’shas since been reverting to its natural state sophisticated securities markets, along withwith the removal of capital controls and the a number of asset managers in Mumbaigradual re-integration of national capital running global portfolios. If the  bondand banking markets; but this time on a market was developed, the South Africanglobal scale. bond issue could be  denominated.  countries opened their capital Global investors would buy these bondsaccounts between  and . A number and trade them on the secondary marketof emerging markets did so in the s in Mumbai. Each of these three steps –– often at the  ’s urging. In , primary market bond issuance by the Souththe  contemplated making an open African entity, primary bond purchases bycapital account a condition of membership. global and Indian investors, and secondaryBut the idea was shelved when the Asian bond market trading by global players –financial crisis erupted in . That was would generate revenues from the export ofprecisely when India first contemplated re- financial services from Mumbai. Creatingopening its capital account. A series of an  in India requires that Mumbai mustsimilar mini-crises occurred elsewhere in be viewed as competitive in the eyes of the engulfing Russia and Latin America. By South African railway and in the eyes of global bond investors, when compared with all these crises were contained. Capital alternatives like Singapore or London.account opening resumed but with reduced The global  market in the stmomentum as the  and others began century is one in which competition is drivento reconsider its benefits and costs. The by rapid innovation in financial products,question of capital account convertibility services, instruments, structures, andnow weighs heavily on China and India, arrangements to accommodate and managewhere financial systems with structural myriad requirements, risks, and a ceaselessweaknesses, legacy constraints and varying quest for cost reduction. Competitivedegrees of State domination now confront advantage in  provision depends onthe irresistible forces of globalisation. seven key factors: Even with an open capital account,some financial services (e.g. deposit . An extensive national, regional, globalbanking) remain local and non-tradable. network of corporate and governmentBut most financial services are now tradable (supranational, sovereign, sub-sovereign
  • 10. xiv R      M  I F C and local) client connections possessed involving complex judgment and intellectu- by financial firms participating in an alisation continue to be clustered at a few international financial centre (). physical locations, where key individuals . High level human capital specialised in meet face-to-face. This is characteristic of finance, particularly quantitative finance, R&D in computer technology – clustered in supported by a numerate labour force Silicon Valley and the Cambridge Corridor providing lower level paraprofessional – despite extensive use of email, voice tele- accounting, book-keeping, compliance phony and video conferencing. India has and other skills. achieved a minor miracle with the explo- sion of export revenues from  services; . World-class telecommunications infras- tructure with connectivity around the yet, these revenues are a fraction of Silicon clock, and around the world. Valley’s. Similarly, routine production of financial services takes place everywhere. . State-of-the-art  systems, capability But, the most important and high value to help develop, maintain and manage decision-making functions are concentrated the highly sophisticated and expensive in a handful of  s that have effectively  infrastructure of global financial (and consequently) become global cities firms, trading platforms and regulators; At present, London, New York and systems that are evolving continuously Singapore are the only global financial to help firms retain their competitive centres ( s). Many emerging  s edge. around the world are aspiring to play a global . A well-developed, sophisticated, open role in the years to come: e.g. Shanghai financial system characterised by: (i) and Dubai. Other  s in Europe and a complete array of proficient, liquid Asia, like Paris, Frankfurt or Tokyo, connect markets in all segments, i.e. equities, their financial systems to the world. But bonds, commodities, currencies and they have lost market share and importance derivatives; (ii) extensive participation in competing for global  for reasons by financial firms from around the explained in the report. The world market world, (iii) full integration of market for  is represented mainly by the ,  segments, i.e. an absence of artificially and Asia which together account for over compartmentalised, isolated financial % of global  . Correspondingly the markets that are barred from having global  market is concentrated in the operational linkages with one another; three s located in each of these regions. and (iv) absence of protectionist barriers and discriminatory policies favouring domestic over foreign financial firms in 2. Implications for India and providing financial services. Mumbai . A system of financial regime governance Given that an  in Mumbai must be (i.e. embracing legislation, policies, rooted in (and serve) India’s financial system, rules, regulations, regulatory agencies rather than be an artificial offshore appendix, etc.) that is amenable to operating on the call for creating an  in Mumbai at global ‘best-practice’ lines and standards; this time is implicitly a metaphor for (and and finally synonymous with) deregulating, liberalizing . A ‘hinterland advantage’ in terms of and globalising, all parts of the Indian either a national or regional economy financial system at a much faster rate than (preferably both) whose growth is is presently the case. Raising the issue of generating rapid growth in demand for an  in Mumbai now suggests that the . pressing need for a new, more intensive phase of deregulation and liberalization of Advances in information and commu- the financial system has been anticipated nications technologies ( ) have eased by India’s policy-makers and regulators interactions over a distance and reduced their cost dramatically. However, activities  To understand what such a city is see Sassen ().
  • 11. Executive Summary xvand that the  is a device to accelerate gap in capabilities that now exists betweenmovement in that direction. An  will Mumbai and established s.not be created quickly in Mumbai, nor willit succeed, if action on further deregulation 3. The difference between BPOand liberalisation is not taken in real time. and IFS In sustaining its trajectory as anemerging, globally significant, continental The production of financial serviceseconomy, the  believes that India has worldwide is now fragmented into a seriesno choice but to: (a) become a producer of interrelated sub-processes undertakenand exporter of  ; and (b) capture an separately. Business process outsourcingincreasing share of the rapidly growing ( ) of individual processes occurs atglobal  market. To achieve these a considerable distance from the pointtwo goals, its financial centre in Mumbai of customer contact where their eventualmust compete to become a successful resynthesis occurs. India is now a highly. Incremental growth in the global successful  venue for the global financial market is now being driven by the services industry. In the last five years, it hasgrowing demands of China, India and gone beyond simple  towards complexA. With its strengths in human capital, knowledge process outsourcing or . Thisa globally powerful  services industry, and is a positive development for India to realiseits own hinterland, India has many natural its ambitions of creating an  in Mumbai.advantages for competing successfully in this Finance-related / builds up skillsmarket. In evolving as an , Mumbai will in India and increases the ‘mind-share’ ofprobably grow in two distinct phases: India amongst global finance professionals. However, there is a substantial differ- . In the first phase (–) Mumbai ence between / and providing  must connect India’s financial system via an . Financial processes that get out- with the world’s financial markets sourced under  involve low-value, low- through  . That is what  s like skill tasks. They are codified in a manual that Frankfurt, Paris, Sydney, Tokyo and a indicates how tasks are to be performed, con- host of smaller s do now in respect trols quality/integrity, and measures whether of their national economies. they are being done correctly. Once the pro-. In its second phase (–) Mumbai tocols are in place, the task is performed must develop the capacity to compete repetitively. But some outsourced activities with the three established  s for in finance, involving research and analy- global  business that goes beyond sis, are moving up the  value chain. meeting India’s needs. After ,  For example, company financial analysis, would hope that Mumbai would hold its credit research, and stock market research own in competing with the other s functions are now also being outsourced. and acquire increasing global market Still, the real value in financial services share. provision remains concentrated in a small number of jobs performed by qualified, India’s financial services industry will super-numerate, imaginative people withnot become export-orientated, nor derive the specialised expertise, experience, domainsignificant  export-revenues, if Mumbai knowledge and skill-sets to be innovativefails to become an  . That will in designing financial instruments andcompromise not just export earnings from structures. Such people have extensive cross-, but the quality, efficiency and range of border networks of clients and colleagues.domestic financial services offered in India Their work involves fine judgment inas well. For Mumbai to become an  , making decisions covering a vast array ofIndia’s policy-makers and financial operators circumstances. It cannot be scripted inneed to understand fully the nature of and a manual codifying its mechanics. Suchopportunities in: the global  market; judgments rely on intensive interaction,the activities undertaken in s; and the inter-personal information flows, and
  • 12. xvi R      M  I F C complex negotiations among a number We categorise s in this report in four of highly qualified professionals including ways; i.e. as: financial experts, specialised corporate Global (GFCs ) These are centres that gen- lawyers, accountants, tax experts, etc. Such uinely serve clients from all over the interaction takes place at an . world in the provision of the widest From an Indian perspective, further possible array of ; progress with expanding the  / chain in financial services (horizontally and Regional (RFCs) They serve their regional vertically) is inevitable and positive. But that rather than their national economies should not be confused with what is required (see below) – examples of such s would be Dubai or Hong Kong ; to provide the full array of  via an . Intuitively, moving up from / to a Non-global and non-regional, ordinary inter- fully fledged  is analogous to moving up national IFCs These are centres like from low-end programming to replicating Paris, Frankfurt, Tokyo and Sydney Silicon Valley. Incremental progress in the that provide a wide range of  but Indian  industry will not bring Silicon cater mainly to the needs of their na- Valley to India; that requires a quantum tional economies rather than their leap. Similarly, doing more  / regions or the world – one might be for the global financial services industry tempted to call them national s al- will not, as a matter of course, result in though that term is an awkward one because its two defining adjectives are India automatically graduating to providing contradictory; and  through natural evolution. / will be done by specialised sub-contractors Offshore (OFCs) These are centres that are with different skill sets and competencies. primarily tax havens for wealth man-  can only be provided by qualified agement and global tax management and internationally known financial firms; rather than providing the fully array which is what Indian financial firms must of . quickly strive to become. India’s growth in The  products and services that / is about doing more through  s provide include the following eleven services firms (like Infosys, Satyam, Wipro activities. s provide all of them. Other or  ). India’s growth in  is about s provide some combination of them. exporting  through established and new financial intermediaries. a. Fund Raising: for individuals, corpo- rations and governments (sovereign and sub-sovereign). This includes debt 4. What are International and quasi-debt across maturity/currency Financial Centres (IFCs) and  Singapore and London are also regional in the Services (IFS)? sense that they serve Asean and the  while New York Financial centres that cater to customers serves North and Latin America. But because these three centres serve the global economy, well beyond outside their own jurisdiction are referred to meeting the  needs of their respective regions, we as international ( s) or regional ( s) classify them as global rather than regional. In that or offshore ( s). These three different sense, the  sees limited potential for Mumbai adjectives are often (but wrongly) used to be a regional financial centre for South Asia given current geopolitical realities. South Asia is more likely synonymously in the literature. Yet these to be served by Singapore and Dubai for the time being. three types of  s are difficult to define We see Mumbai being an  that serves India in the in a clear-cut, mutually exclusive fashion; first stage and leapfrogs to serving the global economy in its next stage of evolution. Ironically, Mumbai as an although they are quite distinct. All these  is likely to serve its region after it serves the world, centres are ‘international’ in the sense that rather than before. For that reason, although the  they deal with the flow of finance and was asked to look into Mumbai becoming a regional financial centre we dispensed with that characterisation financial products/services across borders. early on in the knowledge that it would be misleading. But that description does not differentiate Throughout this report therefore we refer to Mumbai them sufficiently in terms of their scope. becoming an international rather than a regional FC.
  • 13. Executive Summary xvii spectra; equity and quasi-equity for pri- will become increasingly important to vate, public and public-private corpora- Indian firms as they evolve into s. tions; as well as risk-management appen- f. Global/Regional Corporate Treasury dices attached to primary fund-raising Management Operations: involves transactions to ensure that the risk expo- fund raising, liquidity investment and sure of the primary borrower or fund- management, asset-liability and dura- raising entity (to currency, interest rate, tion matching, and risk-management credit, market, operational and political through insurance and traded deriva- risks) does not exceed tolerable limits. tive products for currency, interest-rate,b. Asset Management and Global Port- credit and political risk exposure. folio Diversification: undertaken by a g. Global/Regional Risk Management Op- variety of national, regional and global erations and Insurance/Re-insurance: asset managers including, inter alia pen- which involves highly developed ex- sion funds, insurance companies, in- change traded and tailored derivatives vestment and mutual funds of various (futures, options, swaps, swaptions, caps types characterised by nature of instru- and collars) as well as world class deriva- ment (i.e. debt, equity or convertibles), tives exchanges that trade a variety of geography, or sector of activity. global contracts.c. Personal Wealth Management (PWM): h. Global/Regional Exchange Trading of for high-net worth individuals (s). Financial Securities, Commodities and This activity is estimated to involve the Derivatives Contracts in Financial In- management of personal assets of $– struments/Indices and in Commodi- trillion worldwide. Overseas Indians ties: There is an increasing tendency to- are estimated to hold financial wealth ward multiple listings of financial securi- (i.e. apart from real estate, gold, art, ties (equities and debt), and of derivative etc.) of over $ billion and total and commodity contracts, on different wealth of over $ trillion. PWM takes exchanges with emerging investor de- place in established  s, but is more mand for  x  x  trading of all listed skewed towards specialised -s securities across all exchanges. Demand in the Channel Islands, Switzerland, is highest for the securities of index- Luxembourg, Monaco and Lichtenstein corporations in each major capital mar- for the  and Africa; Caribbean ket. It will gradually cascade downwards offshore centres for the  and Latin to cover global trading of all listed se- America; Bahrain and Dubai for the curities in all markets – developed and Middle East; Singapore, Hong Kong and emerging. Mumbai is better placed than some Pacific Island offshore centres for most s to meet this demand, because East/North Asia. of its human capital and  capability,d. Global Transfer Pricing: This is an as well as its world-class exchanges and activity that o, like most governments, improving exchange regulation. looks askance at, but needs to realise i. Financial Engineering and Architec- and accept the reality of, in a global ture for Large Complex Projects: This economy dominated by transnational primarily involves energy and infras- corporations. This will become tructure projects requiring funds from increasingly important to Indian firms a variety of global sources (public and as they evolve into multinationals. private) with attached risk-management.e. Global Tax Management and Cross- Again, Indian financial institutions and border Tax Liability Optimisation: former FIs have well-honed skills in this which provides a business opportunity particular arena. for financial intermediaries as well as j. Global/Regional Mergers and Acquisi- accountants and law firms until national tions Activity: This will become increas- tax regimes begin to converge toward ingly important in India and for which a global low tax norm. This activity a considerable amount of back-office
  • 14. xviii R      M  I F C / and due diligence research limits set by RBI. The ability of Indian work is already being outsourced to In- households to move resources across the dia. border has increased with India’s increasing k. Financing for Global/Regional Public- openness. The proliferation of Indian s Private Partnerships: This relatively operating around the world – and transfer new activity has emerged on scene with pricing with their subsidiaries abroad – considerable force since the development has led to  demand for fund-raising, of the London Underground PPP. It has corporate treasury management and global particular and immediate relevance for tax management. With rapidly increasing the financing and rapid development of annual flows, the stock of assets outside the Indian infrastructure without recourse country controlled by Indian households to the treasury. and firms is rising rapidly. These assets require  for wealth, asset and global 5. Growth and globalisation tax management. All these phenomena imply inevitable increases in  purchases drive India’s demand for IFS associated with the growing size of cross- Since , India has grown rapidly and its border flows. Calculations in this report economy has globalised. As India grows, suggest that on average, the  revenue it globalises faster. That happens through stream works out to % of the gross flows the increased share of trade and foreign across the boundary. investment in economic activity. Evidence of This translates to about $ billion of that lies in two-way cross-border flows. Such IFS purchases by Indian clients in . flows, on the current and capital accounts Looking ahead, India’s engagement with combined, rose from $ billion in  the world will intensify in three ways: (a) (<% of  ) to $ billion in  reduction in barriers such as customs duties (>% of ). The forces that resulted in and capital controls; (b) improvements in this six-fold increase are intensifying and will infrastructure; and (c) greater participation further accelerate growth of cross-border by s (Indian and foreign) in the Indian flows. The next decade is likely to see cross- economy. These developments will induce border flows growing as fast. deeper globalisation of the Indian economy Current and capital account flows in- in the coming decade, inducing an upsurge variably necessitate purchases of  . For of  purchases. example, current account transactions in- Our estimates suggest that IFS pur- volve payment services, credit enhancement, chases by Indian households and firms will currency risk management, etc. Capital ac- rise to $ billion by  on the basis of count flows involve purchase of investment conservative assumptions in a ‘base-case’ banking, legal, accounting, risk manage- scenario. Under more propitious circum- ment, research and other similar services. stances (e.g. if GDP growth is sustained at When  / enters or exits India, fees %) that figure could be over US$ billion. are paid to various  providers (e.g. com- By  that amount could exceed US$ mercial and investment banks, securities billion in nominal terms. brokerages, exchanges, insurance compa- These estimates warrant a different way nies, asset managers, etc.). As India engages of thinking about  exports and about more with the world, the stock of assets held an  in Mumbai. Traditional conceptu- in India by foreigners rises. Similarly, the alising by Indian exporters about market stock of foreign assets held by Indian house- opportunities typically assumes tapping into holds and firms also rises. Purchases of risk a quasi-infinite world market. Financial ser- management services grow in proportion to these stocks which are far larger than the  This was the approach taken by the Indian software capital flows of any one year. industry which now has domestic sales of a mere $ million while its exports are a -fold multiple of It is estimated that Indian households roughly $ billion a year. The search for growth on have accumulated considerable wealth the part of firms like , Infosys or Wipro has been outside the country; well beyond the present primarily about finding international customers. The
  • 15. Executive Summary xixvices are like software services in that they are exists for Indian financial genius to achievelabour, skill, /communications intensive. similar export success in world markets;But, in terms of market opportunity, there is but with one key difference. India’s owna fundamental difference between finance growth and globalisation, and consequentand software. It lies in India’s hinterland domestic demand for , generates naturaladvantage. Rapid growth, even more rapid opportunities for  producers in Indiaintegration with the rest of the world, and (local and foreign) to acquire  skills andthe high consequent growth rate of two-way exploit economies of scale. Indian softwarecross-border financial flows now being seen, exports required an enabling frameworkall serve to make India a large and growing from the State in the form of telecomcustomer for . Unlike  service exports, reforms. Indian  exports will requireIndia provides a platform for nurturing  a similar enabling framework from thecapabilities that can ‘go global’ instantly. State. Deeper and wider reforms and Against that growing demand for , a improvements are needed in: (a) India’sfailure to respond on the supply-side, (i.e. financial system and the way it is governedby creating a successful  in Mumbai) and regulated; as well as (b) Mumbai’s urbanwill simply oblige Indian customers to infrastructure and political/administrativedo increasing  business abroad. That governance on a scale not yet envisaged.will fuel the growth of Singapore, Dubai,London and other  s while depriving 6. India’s competitiveMumbai of capturing opportunities for high advantages in creating anvalue-added  exports. For example, IFCthe Tata Steel-Corus deal generated revenues in Singapore and London. Some Hinterland Advantage: As argued aboveelements of such transactions do not appear the growth of the Indian economyin Indian BOP accounts. Financial firms and and more rapid growth of cross-policy makers in the three s and  border financial flows have createdare highly attuned to the opportunities substantial local demand for . Thisfor selling  into India. They have ‘driver’ supports the development ofembarked on strategies that exploit the skills, and generates economies ofcurrent infirmities of the Indian financial scale on the part of financial firmssystem. The most capable Indian financial operating in Mumbai. China has thefirms are likely to move to these centres in same hinterland advantage. New Yorkorder to acquire the flexibility to provide has the North American economy astheir extant client base with the  they its hinterland. London has the evenneed, rather than risk losing their clients to larger  economy, as well as its ownglobal financial firms. national economy, to serve. Singapore Rapidly growing demand for  in has a limited national economy. But it is the financial epicentre of anIndia provides an opportunity for its A regional economy that isfinancial services industry that its software almost as large as China and largerindustry never had. Indian software exports than India. Dubai does not havewere generated by ingenious Indian human that kind of national or regionalcapital exploiting foreign markets and economy. But it is located in a regionrequiring nothing from the State other that is generating enormous financialthan telecom reforms. Indian  genius surpluses for investment abroad.conquered world markets between  and Human Capital: India has four strengths in a way that was not imagined in even by way of human capital endowmentsthe most optimistic forecasts of . In that give it a competitive edge overthe case of  , an identical opportunity Shanghai, Singapore and Dubai: • The extensive use of English,domestic market does not loom large to the  s ofthese firms, and played no role in their graduating into which is the lingua franca ofexport-oriented MNCs. international finance
  • 16. xx R      M  I F C • Generations of experience with upholding liberal values, protecting entrepreneurship, speculation, property rights and maintaining trading in securities and deriva- political stability. It fares well tives, risk taking, and accounting. compared with China, Singapore or Indeed the ability to provide  Dubai but does not match London or seems to be genetically coded into New York. Indian finance professionals Mindshare: High  growth, the • Strong skills in information tech- / phenomenon, and the nology and quantitative thinking success of Indians in global finance all over the world, ensure that India • Individuals of Indian origin play has significant ‘mindshare’ at policy- a prominent role in the top  making levels in global financial firms. global financial firms. They are India has an edge over Singapore and well-positioned to intermediate Dubai, and perhaps even over China, between the business strategies of in this respect. these vital firms and the genuine strengths and weaknesses of India Strong securities markets and advanced trad- as an . ing platforms: India has the foun- dations for providing global  by Location: Mumbai is well located in being virtue of its dynamic, technologically able to interact with all of Asia capable securities trading platforms and Europe through the trading day. in the  and . These are the Apart from the Americas, transactions rd and th biggest exchanges in the with most of world  can occur world measured by number of trans- in daylight. Given the remarkable actions. India has an edge over China and growing role of London in and Dubai, but not over Singapore, in providing global  today, India has this respect. the advantage of having a – hour overlap with London time. There is Taking these formidable advantages into no  operating within an hour’s account, the initial conditions supporting variation of the Indian Standard Time India’s entry into the global market for  zone. India has an edge over Shanghai, are promising; especially when compared but not over Dubai, in this respect. with the early days of software exports Democracy and Rule-of-Law: Properly from India. In the latter case, there was functioning financial markets require no hinterland advantage, location did not a constitutional basis and machinery matter, democracy did not matter, and there for system governance that is stable, was no beach-head. The six comparative reliable, resilient and flexible; i.e. and competitive advantages that India has, one that reduces future political suggest that there is a genuine opportunity risks and uncertainty. Globally for India to create a viable  able to credible financial systems need to compete with the best in providing  to be rooted in legislative, judicial, and the Indian and global markets in a short span regulatory frameworks that adhere of time. But, it confronts some daunting to rule-of-law and respect/protect challenges. Our report highlights these in property rights; in principle and detail. They include: (a) financial regime in practice.  can be provided governance in India; (b) missing markets credibly only from environments that and institutions and (c) urban facilities and permit open and honest expression governance in Mumbai. of independent views by portfolio managers, analysts, commentators, 7. Financial regime governance: researchers, etc. even when such views policy and regulation contradict those of governments and powerful personalities with a vested A sound basic framework for develop- interest. India has proven strengths in ing/applying law and regulation are intrinsic
  • 17. Executive Summary xxito  . The quality and credibility of  traded volumes – in all areas other thanprovided from India is inextricably linked to equities. A normative rule-of-thumbthe soundness and global acceptability of the would suggest that the traded volumeregulatory/legal system that governs finance of an exchange-traded futures contractin India. Global competition in  is, to in India should be at least one-tenth thean extent, a function of global competition turnover of a corresponding product in(in terms of reputation, capability, efficiency the  . By this yardstick, the turnoverand effectiveness) among regulatory regimes of Nifty futures is about that size. Butand the institutions that apply those regimes. that is not the case for almost all of theThe market share of an  is determined as top  underlying contracts in the .much by the quality and reputation of its • An inadequate universe of institutionalregulatory/legal regime as by the abilities of investors: The second deficiency inits financial firms. A cross-country assess- India is a universe of institutionalment suggests that India is weak on many investors that have the size, visibilityaspects of the legal and regulatory frame- and capability of those in establishedwork governing its financial system which s. The progress made so farthe report discusses in detail. The report with liberalisation has been basedalso identifies two key strategic institutional largely on speculative price discovery(or structural) weaknesses in Indian finance by non-institutional investors in equitythat impede  production: markets. Other segments are dominated by state-owned entities which are • ‘Missing’ Debt, Currency, and Deriva- bound by restrictive rules. Banks and tives Markets: The most critical finan- insurance companies are restrained, if cial market components missing in In- not banned, from undertaking risk- dia are: a properly functioning bond hedging activities and other kinds of market, a currency market and a deriva- sophisticated business due to regulatory tives market for currencies and inter- restrictions. Consequently their assets est rates. These three interlinked mar- are growing too slowly. kets are termed collectively as the bond- Indian financial firms tend to operate currency-derivatives ( BCD ) nexus in in one key business segment at a this report. Six specific deficiencies time. Their portfolios are narrowly in this respect include the absence of: confined and concentrated; so is their (a) a liquid and efficient sovereign risk exposure. That has stunted their bond market with an arbitrage-free growth, imagination and ability to  yield curve, (b) a wide range of handle risk. Indian financial firms now essential derivatives on  interest need to evolve into full fledged large, rates, (c) a liquid spot market for - complex financial institutions (s in denominated corporate bonds, (d) credit Basel parlance). They need to operate in derivatives on credit spreads or credit all financial market segments of finance events, (e) a liquid currency market and to come up with credible  offerings (f) a full range of currency derivatives. and ‘packages’ for the export market. Under a functional  nexus, all India lacks domestic commercial and six elements are based on vibrant investment banks capable of taking on speculative price discovery, and are global counterparts without higher levels tightly knitted by arbitrage. They of capitalisation, global market access, interact to result in market efficiency.  operational expertise, and high- There is no successful  that lacks such level human capital. India also lacks a  nexus. Its conspicuous absence large securities brokerages capable of in India handicaps the country’s ability competing with global counterparts. to provide  . Another shortcoming India’s brokerage industry reflects the is the inadequacy of India’s spot and infirmities of its retail sector as a derivatives markets – in terms of the whole. It is characterised by too variety of contracts traded and their many small, undercapitalised, limited-
  • 18. xxii R      M  I F C capability firms (brokers and sub- regulation. There is no  that has so brokers) that are mostly still single compartmentalised an approach to the proprietorships in corporate form. structuring, management and regula- Structural reforms are required urgently tion of its financial markets. Reversing to create Indian financial firms that are counterproductive segmentation of fi- equivalent in size and capabilities to nancial markets in India, and removing global counterparts. Looking ahead, barriers to entry, would result in greater: if India is to create an  , there is no economies of scale/scope, competition, escape from inviting the participation and global market-reach. of domestic and foreign institutional • Inhibiting Financial Innovation: investors of adequate size, who would Whether an  should be created for deploy the economies of scale, global India to catch up with the world, or to ex- market-reach and efficiency-enhancing ploit comparative advantage in a global behaviour that is evident at other s.  market, a considerably faster pace Why does India have these weaknesses? of financial innovation in India is essen- Close scrutiny of the regulatory regime tial. But, financial regime governance in examines the origins of these infirmities India can only cope with change slowly. through a matrix that identifies and analyses The regulatory approach to any change restraints on the activities of different in the structure or functioning of the financial firms in providing various  . financial system is conservative, cautious Such a matrix has been prepared as a and inconducive to innovation. As a ‘wallchart’ for this report. It outlines result India falls behind international activities that take place at  s and practice by the day in every market seg- the kinds of financial firms that typically ment. The default signal emitted by undertake them. A careful analysis of this Indian regulators when faced with any wallchart reveals that, at present, most of new idea seems to be set at ‘amber’ if not the  activities that take place at  s ‘red’. Innovative instruments, contracts are banned or severely proscribed in India. and new ways of doing business are acted The red ink across the wallchart – signifying upon in days in the three  s. Such activities banned in India – portrays the a pace of rapid progress is not found license-permit-control raj that still operates in India. Basic contracts like interest in Indian finance. It retards development rate futures and options have failed to and sophistication of the financial sector materialise in this climate. and inhibits  exports. A pragmatic view of these constraints highlights three urgent, Deregulation and liberalisation through cross-cutting priorities for reform: the s have largely unshackled India’s manufacturing sector, and much of its • Competition Policy: India’s experience real economy. Competition, innovation with liberalisation in the real economy, and scale economies in these sectors are suggests that the most powerful tool for no longer blocked by the State. Yet, having efficient and well-functioning somewhat dissonantly, a much higher degree firms is competition. Application of of control continues to operate in key sound competition policy in all market parts of the financial sector; despite the segments of India’s financial sector is many regulatory reforms of the s. This now a matter of urgency. financial governance regime now needs to • Compartmentalisation of the Finan- be overhauled to create a more modern cial System: Global competitiveness re- governance regime. It does not need quires exploiting fully the economies traditional fine-tuning with the extant of scale and scope. India’s hinterland regime remaining largely intact. advantage represents an opportunity Regulatory reform has had a positive to exploit such economies. However impact on the functioning of India’s capital Indian finance has been artificially frag- markets and the insurance sector. In the mented by financial sector policy and capital markets, India has achieved global
  • 19. Executive Summary xxiiistandards in some aspects. Other financial  in Mumbai. The goal of publicmarkets lag behind in not yet having been policy is to foster high economic growthreformed as widely or deeply. Despite the and enhance welfare in India; it is notpresence of a large number of different types to cater to the interests of Indian firmsof banks, and despite incremental measures or their shareholders. But, in sayingaimed at ‘opening-up’, the banking market this, the  is mindful of the realityin India has yet to improve substantially that developments during the last decadein competition, innovation and efficiency. have resulted in a debilitating anomalyThe improvements achieved at the margins for Indian financial firms versus theirhave not yet permeated the banking system foreign competitors. In manufacturing,as a whole. They are unlikely to, without the removal of barriers to imports wasa major reformative push and diminished accompanied by a simultaneous unshacklingpublic presence. of Indian firms. Indian firms were exposed For that reason, a dramatic change to greater competition from imports andin the governance regime for all financial the entry of foreign  s in domesticmarkets in India is now imperative. Without market space. But they were, simultaneously,it India will not be able to create an given a transitional period and considerableinnovation-orientated financial system freedom in terms of formulating businessthat can evolve and compete at a pace strategies and innovating.commensurate with changes in the Indian The evolution of Indian finance,economy and global finance. Such a in contrast, has resulted in growingsystem would have the following activities dissonance between external competitionundertaken on a par with global norms: and a repressive license-permit raj. India’s(a) continual innovation and improvement long and tortuous evolution towards de factoin the design of financial products and convertibility (which in some respects iscustomer services as well as in their delivery; not dissimilar to tariff reductions in the(b) the rapid reintegration of segregated real economy) has not been accompaniedfinancial markets into more liquid and more by Indian financial firms being given theintegrated markets; and (c) the rapid growth same opportunity and room for manoeuvreand market-induced consolidation of Indian to develop their competitive firms in a manner that enables They are at a disadvantage in coping withthem to achieve economies of scale. competition (for their clients’  business) For this to be achieved, Indian financial from global  providers operating in Indiasystem regulation needs to be brought up and from abroad for two reasons:to world standards. Regulatory attitudes, • First, key financial markets (i.e. thepolicies, practices as well as institutional  nexus and risk management) havearrangements need to undergo a sea- been prevented from developing in Indiachange. They need to become more because of regulatory restraints. Thatattuned to, and supportive of, the dynamism, has resulted in Indian financial firms notgrowth and global competitiveness of the having the opportunity or the time/spaceIndian financial services industry. Policy to develop domain knowledge and skill-and regulation must adjust and adapt to sets in crucial areas e.g. global fund-the needs of Indian and global financial raising or developing sophisticated riskmarkets. Financial markets should not management products/services tailoredbe artificially fragmented, segmented, to client needs.compartmentalised. • Second, the same regulatory restraints This report does not advocate using have deprived Indian financial firms ofthe hinterland argument as a reason the freedom they need to develop andfor protectionism. Nor is the  the necessary flexibility in formulatingmaking an argument for ‘self-sufficiency’. global business strategies. They have notInstead the  believes that India and had the scope for innovating for  andIndian financial firms should be globally thus developing the skills required tocompetitive in providing  through an compete with global  providers.
  • 20. xxiv R      M  I F C The  is clear that, in providing debt of centre and states, including on-  from India, there is no case whatsoever and-off-balance-sheet liabilities (such for protectionism. The interests of Indian as pensions) and endorses a lower customers, and that of economic efficiency, level (than the present %) for the are best served by enabling them to choose total consolidated public debt-to-GDP from the best  providers in the world. ratio. A public debt ceiling should be But, the asymmetry in policy that has placed bolstered by flexible triggers for actions Indian financial firms at a disadvantage, to be taken by the Ministry of Finance underlines the case for phasing reforms (e.g. accelerated sales of public assets aimed at creating  capabilities in a whose proceeds are used to liquidate manner that enables Indian financial firms outstanding public debt if that is deemed to be similarly unshackled in competing to appropriate) when the adopted debt provide . ratio ceiling is breached. While the  did not wish to recommend a particular debt ceiling ratio without 8. Reorienting the financial looking more deeply into the matter, system towards IFS global experience suggests that ratios in provision: A temporal the range of –% are widely applied roadmap for reform as prudent. Such a debt ratio should be added to existing  measures for The strategy proposed in this report for deficit and debt reduction. creating an  comprises in essence a ten- For an Indian  to be credible, in point agenda: keeping with ‘best-practice’ worldwide, . Macroeconomic (i.e. Fiscal and Mone- India’s central bank should be indepen- tary) Management. dent and separate from government. It As a new competitor in global must be independent and separate from financial markets, the credibility of government; i.e. in the same way that India’s macro-economic policies, and the Federal Reserve in the , the  the quality of its macroeconomic and in Europe, the various national central financial system management, will be banks of Europe and Japan, and the Bank judged more stringently than in the case of England, are independent of and sepa- of established  s. This asymmetric rate from their governments. The central reality highlights the importance of bank must employ global best-practices redoubling efforts in reforming policies, in the conduct of monetary policy, in legal and institutional arrangements to order to suffuse international investors achieve and sustain a high growth rate and issuers with growing confidence in (–%) for the economy in general and the  as an acceptable global currency the financial sector in particular. for  transactions. The level of con- Creating a vibrant, competitive  fidence engendered should permit the in Mumbai will require, as an integral  to become one of the world’s major backdrop, success in meeting the reserve currencies by  or  at the legal commitments entered into by latest. the Government of India, and the The gold standard for a stabilising governments of individual states, to monetary policy is a transparent, reduce the consolidated fiscal deficit on independent, inflation-targeting central the timeline announced. In addition, it bank. With such an arrangement the will require (a) reducing the total public Indian State would be: (a) underlining debt/ ratio to more acceptable its commitment to delivering low and levels; and (b) pursuing sound fiscal predictable inflation; and (b) inducing and monetary policies thereafter. greater confidence in the  in the eyes HPEC therefore recommends that of domestic and global investors. The further action should be taken to  recommends that the Ministry reduce more rapidly the consolidated of Finance consider: (a) reforming
  • 21. Executive Summary xxv monetary institutions in the light There is considerable unmet global of recent developments in monetary demand for  bonds on the part economics; and (b) doing so in a way of long-term institutional investors that bolsters the case for a credible  such as foreign pension funds. A in Mumbai. rapidly emerging  bond market  also recommends a fresh look would trigger currency trading in India at applying key principles in guiding and foster the use of  currency reform of the tax system on the revenue and interest rate derivatives. That side, to ensure that India remains would facilitate the evolution of the globally competitive, and avoids price  as a global currency, used as distorting subsidies on the expenditure a numeraire by bond investors and side. This has particular implications for issuers from India and around the ensuring that inflation-targeting is not world. Internationalisation of the  distorted or rendered ineffective because (a prerequisite for a successful  in subsidies (e.g. for key energy prices) Mumbai) would expand transaction emit the wrong inflation signals. volumes in India’s bond, currency. Strategy for Public Debt Financing. and derivatives markets, as well as Traditionally, India has eschewed its equity and commodity markets, bond issuance outside the country, fear- coterminously. It would expand the ing the currency risk that arises with range of financing options open to, issuing forex bonds while having  and seignorage revenues derived by, the revenues. This risk of ‘original sin’ does Government of India and its central not arise if  denominated bonds bank. are sold to meet foreign demand for . Creation of the BCD Market Nexus. such debt. The HPEC therefore advo- The most important missing piece cates opening up fully to foreign invest- in Indian finance is the  nexus ex- ment in INR denominated sovereign plained earlier: i.e. the set of interlinked bonds issued by GoI . It further recom- bond-currency-derivatives markets for mends that no limits should apply to spot and derivative instruments on in- purchases by foreign clients of INR de- terest rates, currencies and credit risk. In nominated corporate bonds or bonds order to ignite these markets, HPEC rec- issued by sub-sovereign entities (states ommends the immediate creation of a and metropolitan administrations). In currency spot market, with a minimum addition, the HPEC believes that the transaction size of Rs.  million, acces- function of a public debt management sible to all financial firms. In addition, office should be placed in the Ministry an INR -settled exchange-traded cur- of Finance rather than in a regulatory rency derivatives market should be cre- institution to avoid any perceptions of ated, with trading in futures, options conflicts-of-interest. and swaps on currencies, accessible to This would achieve two goals. First, it all. would open up a new financing channel These two initiatives, along with for  o (and state and municipal developing more rapidly the spot governments as well) thus enabling market for bonds, need to be merged it to abandon repressive policies that into the existing securities exchange pre-empt domestic savings with an ecosystem so as to trade alongside array of undesirable and unintended the spot and derivatives markets for consequences (e.g. crowding out and equity. The policy problems that undue pressure on the  interest have held back interest rate futures rate). Second, the internationalisation need to be rapidly resolved. The of  bonds (issued by the sovereign, responsibility for regulation of these sub-sovereigns and corporates) would markets – spot or derivatives; exchange accelerate the emergence of an Indian or ; government bonds, corporate  on the world stage. bonds, and currencies – needs to be
  • 22. xxvi R      M  I F C moved to  without further ado . Create wholesale asset management and unified with the regulation of businesses with freedom for outsourc- all organised financial trading. The ing by existing financial firms such as goal should be to create and launch a banks or insurance companies. This significant  nexus, in conformity would separate the legal and contrac- with world standards, within  months. tual structures through which assets . Financial Market Integration and are sourced and securities are created Convergence vs. Market Segmentation – across multiple front-ends across the country – from the ‘factories’ in Indian finance suffers from a frag- which assets are managed. It would mented approach whereby the overall also achieve economies of scale in financial industry has been cut up into asset management. pieces reflecting legislation that is out- dated by  years or more.  exports . Shift away from regulation by entity will not take place as long as the com- to regulation by domain. As an petencies of Indian financial firms are example, IRDA would regulate only artificially stunted. India now needs its the insurance business, not all the own  s present in all lines of busi- activities of insurance companies. ness, and able to achieve economies of . Principles-based Regulation scope and scale. A series of measures Over the decades India has built are needed to achieve market integra- up a license-permit raj in finance. tion and convergence, and thus enable It over-emphasises compliance at the economies of scale, economies of scope, expense of competence, competition greater competition and enhanced IFS and innovation in financial services. export capability, i.e.: A similar raj dominated the real economy since independence. But . Redraft the legal foundations for it was dismantled during the s organised financial trading, so as to the immense benefit of the Indian to unify all organised financial economy and particularly Indian global trading under  regulation. This competitiveness. To achieve the same would include currencies, equities, objectives, that raj in finance now needs sovereign and corporate bonds, and to be dismantled if India is to develop commodity derivatives. It would  provision and export capabilities immediately diminish some of the and if an  is to emerge in Mumbai. fragmentation which has taken place At present financial regulation in In- amongst financial firms. dia is fragmented and rules-based. It is . Remove barriers to a holding over-prescriptive and restrictive of man- company structure through which agerial discretion. In every market seg- virtual financial firms can be created, ment, regulators attempt to codify every with an array of subsidiaries that fit detail of a business in which the shape of Indian regulatory constraints but the future can neither be anticipated nor with corporate headquarters and predicted. Anything not explicitly per- top management able to operate mitted is banned. Any proposed change a unified financial firm. The in the way of doing business requires holding company would be regulated clearance from the regulator. Supervi- only by the Companies Act. It sors apply checklists in verifying that would typically be listed and able to every rule is met while not quite un- leverage itself; while its subsidiaries derstanding all the dimensions of the might be unlisted. All barriers to business possibilities of the regulated M&A in finance need to be identified entity and how it might evolve. This and removed, so as to achieve approach is inflexible and unamenable a market-induced consolidation to swift adaptation of a kind that the process which would permit Indian world of global finance demands. This s to emerge. is counterproductive for the purposes
  • 23. Executive Summary xxvii of fostering  provision capabilities convertibility in any case. Myriad other and inappropriate for an . countries have perfected the combina- HPEC therefore recommends that tion of autonomous monetary policy rules-based regulation in India be and convertibility. India needs to em- replaced by principles-based regula- ulate the dozens of successes, and avoid tion. That will require redrafting In- the mistakes made by the few failures. dia’s securities and banking laws as Having considered the recommen- well as re-skilling of all regulatory staff. dations of the Tarapore- Committee HPEC also recommends that a new Report very carefully, the HPEC nev- unified Financial Services Modernisa- ertheless recommends that full capi- tion Act (FSMA ) be drafted to bring tal convertibility should be achieved together, under a single omnibus leg- within a time-bound period of the next islative umbrella, all aspects of finan- - months and by no later that the cial services: i.e. securities trading, end of calendar . banking, derivatives, insurance and This recommendation needs to commodity-finance. Such omnibus leg- be dovetailed with an - month islation should reflect the holistic nature timetable for acting on  ’s other of the financial services industry while recommendations. That would kill two creating the foundations for regulation birds with one stone. It would accom- to be modernised and, possibly, uni- modate the accepted international con- fied in the fullness of time. This new sensus that a country moving to con- law should draw on the models of the vertibility must have liquid and efficient ’s  and the ’ , and be financial markets and strong institutions. aligned with the shift away from rules- Also, India’s opportunity to export  based regulation that is now being wit- will really open up after convertibility. nessed around the world. The new om- So, between now and then, a window nibus law should embed an appeals pro- of opportunity exists to tackle issues of cedure – under an International Finan- public debt management, and missing cial Services Apellate Tribunal () markets/institutions, with forceful reme- – that allows for: (a) appeal against any dial measures. action of any financial regulator in India; . Taxation of IFS and Financial Trans- (b) broadening the scope of appeal; and actions (c) judges having specialised domain  recommends a rational and knowledge in finance. fair tax system for  which is com-. Capital Account Convertibility petitive by international standards. The The convertibility question is critically  is against creating a tax haven in linked to the possibility of a currency cri- an Indian . sis, which India has successfully avoided A key HPEC recommendation en- over –. This discussion needs dorses the Kelkar Committee Report’s to be illuminated by three key points. proposals for including financial ser- First, the present Indian policy config- vices under the Goods and Services Tax uration is not a ‘consistent’ one, given (GST ) regime with the simultaneous a pegged exchange rate and attempts at removal of all central and state trans- having an autonomous monetary policy action taxes including the Securities while having significant capital account Transaction Tax (STT), stamp duties, openness. This has, in the past, led to etc. These recommendations should be potentially destabilising one-way bets implemented as swiftly as possible. for foreign capital. Second, it is clear . Inducing greater competition and in- that if  export is the goal, this is in- novation in the Indian financial system compatible with capital controls. Third,  has made a series of specific the growing integration of India into recommendations in Chapter . All of the world on the current account and them aim at inducing greater competi- the capital account is giving de facto tion and innovation in the Indian finan-
  • 24. xxviii R      M  I F C cial system and in the provision/export recommendation is made so that In- of  . Apart from what has already dia can catch up quickly with the rest been said about reversing the excessive of the world in becoming a competi- segmentation and compartmentalisa- tive provider of  through an  in tion of financial markets, these measures Mumbai. It will not do so if it is left to include, inter alia: existing domestic law, accounting and • Removing existing barriers to en- tax advisory firms to develop domain try of private domestic corporate knowledge and skill-sets organically – in players in some segments of the fi- coping with the demands for  related nancial services industry; legal, accounting, tax and business advi- • Removing barriers to the entry of sory services –without being confronted foreign financial firms in the pro- with the pressures of competition and vision of IFS on the grounds that innovation in their market. unilateral liberalisation is in India’s Swift implementation of this ten- own interests; point programme, would orientate Indian • Restricting demands for recipro- financial firms towards achieving  export cal market access only to domestic competitiveness. It has ramifications for financial services; macro-economic policy that have already been spelt out. It is consistent with the • Reducing the extent of public own- pursuit of sound practices in fiscal, monetary ership progressively in Indian fi- and exchange rate management. These nancial institutions; recommendations constitute a dovetailed • Removing existing barriers to agenda that would be wise for India to follow friendly or hostile mergers, acqui- in any event regardless of the arguments for sitions and takeovers in the finan- or against an . cial services industry within/across market segments; and • Encouraging the emergence of In- 9. Urban infrastructure and dian LCFIs through market-driven governance in Mumbai initiatives. The lure of the burgeoning Indian market . Improving the performance of the legal has already attracted a large number of system for finance/ IFS foreign financial firms to Mumbai. They HPEC believes that significant im- have, in turn, located an increasing number provements need to be made in the In- of high-level expatriate staff in the city, dian legal system in resolving disputes, creating intense competition and driving adjudicating settlements and enforc- up prices quite dramatically for limited ing financial contracts in real time. If accommodation and lifestyle facilities that that does not happen the prospects for are not yet world class. A Mumbai- Mumbai emerging as an , or aspiring that provides  only to the Indian market to become a  , will be irreparably will not face the same pressures from damaged. foreign firms and expatriates to remedy the . Opening up space for IFS support ser- privations that they presently have to suffer: vices infrastructure i.e. inadequate infrastructure, massive Related to improvements in the le- congestion, rampant pollution, along with gal system as they apply to finance and poor standards of urban governance and law , the HPEC recommends opening enforcement. In  ’s view the present up domestic space to permit the en- state of play can be tolerated reluctantly even try of well-known international law as Mumbai grows as an  in its first phase, firms that operate in other IFCs and connecting India to the rest of the world. GFCs as well as international account- But that can only last for the next five years ing firms and tax advisory firms as well or so. as specialist management consulting In its second phase of growth, if firms focusing on the IFS industry. This Mumbai is to be a successful  that
  • 25. Executive Summary xxixexports to global markets competitively, it and exchanges – even external and globalwill have no choice but to match London, regulatory agency representatives – fromNew York and Singapore in terms of over a hundred different countries. Toattracting the requisite high-level human attract such internationally mobile high-talent to the city. If it fails to do so it will level human capital to an  in Mumbai,not succeed as a . To match these global special efforts will be required on four fronts:cities in the span of the next - years for i.e.their world class quality of infrastructureand their global standards of governance, • First, elementary, glaring deficienciesMumbai needs to make a start now. in Mumbai’s urban infrastructure will The individuals that Mumbai must need to be addressed and rectified on aattract (and who matter most) to be globally war footing. These deficiencies have,competitive in providing  – whether over the last decade or more, beenIndian or not and whether working for discussed in central, state and municipalIndian or foreign firms – are affluent, mobile, government circles, the media, theand multi-culturally inclined in terms of corporate world, and by the publictheir habits, tastes and preferences. They at large. Progress in addressing thesedemand world class facilities to live, work deficits is now being made. Theand play, as well as world standards of  was assured by the  ofinfrastructure and urban governance. They Maharashtra that the pace of progresshave ample choice in terms of where they was about to accelerate. Mumbai’s(and their families) choose to be located, deficiencies include: crumbling housingand how their time is allocated. Whether in dilapidated buildings pervading thethey choose to locate in Mumbai will be city; poor road/rail mass transit as wellinfluenced by the attractions of Mumbai as a as the absence of water-borne transportglobal city in which they can live, work and in what is essentially an island-city;play in a manner similar to what they can absent arterial high-speed roads/urban expressways; poor quality of airports,do in other s. This reality may involve airlines and air-linked connectionsthe creation of facilities to support lifestyles domestically and internationally; poorthat could result in increasing social tension provision of power, water, sewerage,in the city; that risk will need to be managed waste disposal, as well as a paucity ofsensitively and adroitly. high-quality residential, commercial, For Mumbai to become an  that can shopping and recreational space thatoperate on a par with the three established meets global standards of construction,s, it will eventually need to attract a finish and maintenance.large population of individuals who arean integral part of the globally mobile • Second, Mumbai will need to be(globile) finance workforce that already exists. seen as a cosmopolitan metropolisPerhaps –% of them will be of Indian that welcomes and embraces migrantsorigin. The remainder will be expatriates from everywhere – from India andfrom around the world representing every abroad. That will mean providingcountry that has significant trade and more user-friendly visa/resident permitinvestment links with India (and Asia). mechanisms, making all arms ofMost of them will be working for foreign government expatriate-friendly, andfinancial firms that will include, inter exhibiting a gentle, tolerant, open andalia: commercial and investment banks, welcoming culture.asset management companies, insurance • Third, lifestyle facilities that concerncompanies, securities and commodities human welfare will need to be broughtbrokerages, bills discounting houses, private up to world standards and run onequity firms, venture capitalists, hedge funds, world-class lines in terms of theiras well as the financial media and financial management and growth. These include:reporting agencies (such as Bloomberg, hospitals and the health system (publicReuters, major global financial publications) and private); educational facilities
  • 26. xxx R      M  I F C such as primary/secondary schools, waste of resources on purchasing services colleges, and universities; recreational that India could provide more competitively facilities such as sports stadiums (for for itself. Moreover, an inability to meet a wide variety of sports and not its own needs – and those of its trading just cricket), gymnasiums, cinemas, and investment partners – for  will theatres, parks, clubs, hotels, bars, compromise India’s growth. restaurants, racecourses, casinos and Oddly enough, India does not need to other entertainment avenues; as well as rely on foreign providers for  . Quite cultural institutions such as libraries, art the contrary: India has several significant galleries, museums and the like, catering strengths that give it an edge in providing to global tastes.  not just to itself but to the rest of the • Fourth, the quality of municipal and world on a competitive basis. Indeed, there state governance, the provision of per- is no city in the world that can become an sonal security and of law enforcement,  on the scale of London or New York, will need to improve dramatically from within a -year horizon, in the way that third-world to first-world standards to Mumbai can. This reflects India’s unique accommodate an . That is likely to strengths of: democracy, open-mindedness, prove the greatest challenge of all. cultural comfort with foreigners living and Of course, Mumbai needs to tackle these working in Mumbai, use of English, a well infrastructure deficits for reasons other than placed time zone, high quality labour force, becoming an  . The  is too small a  year tradition of speculation and risk a tail with which to wag the much larger taking, and a hinterland advantage. urban development dog. But the case for an But such a future for Mumbai is far  would be immeasurably enhanced if it from guaranteed. At present, India is succeeds in doing so. For that reason,  absent from the global  space, owing recommends a fresh attack on the legal issues to weaknesses in financial sector policy, of urban governance, in a cohesive effort, financial market structure, financial regime undertaken on a war-footing, between the governance, legal system infirmities, as Centre, Maharashtra and Mumbai. The well as in the urban infrastructure and aim must be to create a city government governance of Mumbai. The situation with the necessary autonomy, accountability is worse than initial conditions were for and power to provide local public goods in manufacturing and software exports in . Mumbai in a reasonably unfettered fashion. India does not have a low market share in Mumbai’s needs must be met irrespective of the global  market: it has a zero market rural versus urban considerations. The city’s share. administration must have an earmarked Looking ahead, the growth of  funding stream through tax sharing, in demand in India is inevitable, given the addition to user charges and property taxes sheer growth of cross-border flows. The that it can levy independently, to finance the pressure of  demand that will flow from creation of a ‘global city’ in Mumbai. cross-border transactions of $– trillion per year will inevitably trigger the emergence of rudimentary  capabilities in one way 10. The choice or another. The question that India faces is India has already become a large purchaser whether incremental evolution towards a of  from the rest of the world; much limited range of  capabilities is adequate, larger than is realised in policy-making or or whether there is a more promising future commercial circles, leave alone by the public for India in exporting . at large. As its economy grows, its demand If decision-makers fail to tackle the for  will increase in a non-linear fashion. policy issues outlined in this report, Indian India can, of course, choose to continue  demand will fuel the growth of Wall buying  from abroad indefinitely. But Street, Singapore,  and the City the amounts it will need to spend for that of London; often through the aegis of purpose are staggering. They represent a Indian financial firms that will graduate
  • 27. Executive Summary xxxiinto multinationals and relocate their   path, are much greater than theoperations outside the country. direct revenues that would accrue from The maturity of Indian finance in , sale of  to local and foreign terms of coping with competition and India’s experience with manufacturing hasglobalisation, is comparable to where Indian demonstrated that outward orientation andmanufacturing stood in . The export export competitiveness are the best toolsof financial services from India in  for producing world class quality for thesounds about as unlikely today as the export domestic market. An Indian financial sectorof automobile components or software that can export  will do a better task ofsounded in . The outlook for export of financial intermediation for India. That isautomobile components or software in  likely to generate an acceleration of was nothing but bleak. Yet India managed growth as growing investment resourcesto find the energy to unleash revolutionary (now exceeding % of  ) are morechanges in policy. efficiently allocated. Such radical changes now need to be These benefits need to be weighedreplicated in finance, if export competitive- carefully by India’s leadership against theness in the provision of financial services political capital that needs to be expended(domestic and international) is desired and in overcoming the technical and realpolitikto be achieved. Visionary thinking needs to constraints of: (a) changing the financialbe applied to issues of financial architecture, system in India with a second, morethe role of the central bank, and regulatory intensive set of reforms; and (b) urbanphilosophy. governance in Mumbai. In parallel, Mumbai needs to become a This report has tried to bring objectivityfirst-world city that can attract the brightest and professional competence to sketchingminds of the world by being an attractive the trajectory, should India’s leadershipplace to live, work and play. decide to take the  path. It strives to If India is able to meet these twin deliver a nuanced appreciation of the likelychallenges, then  exports could outstrip costs and benefits of the path to an  , service exports by . The benefits based on understanding of which policy-to the Indian economy, from taking the makers can make a reasoned choice.
  • 28. xxxii HPEC Report on making Mumbai an International Financial Centre: Timelines for Recommended Actions Recommended Actions 2007 by Quarter 2008 by Quarter 2009 by Quarter 2010 by Quarter 2011> 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 YearA. Actions on Fiscal Deficit, Tax and Public Debt Financing/Management Fronts: 1. Achieving and maintaining an average growth rate of 9% to 10% Increase to 9% Increase to 9.5% Increase to 10% Maintain at 10% or more 2. Reduce the gross consolidated fiscal deficit (GCFD) from 8+ to 4–5% of GDP. Reduce to 7%by y.e. Reduce to 6%by y.e. below 5% 3. Reduce total public debt to GDP ratio from 80% of GDP to significantly less. Reduce to 75% Reduce to 70% Reduce to 65% Reduce to 60% <50% 4. Implement the FRBM Task Force Report of 2004. Implement 40% Implement 70% Implement 100% Implementation Completed 5. Eliminate Securities Transaction Tax (STT) and Stamp Duties (SDs). Eliminate STT Eliminate all SDs All Transactions Taxes, Stamp Duties eliminated 6. Apply GST to the financial services industry. Technical Studies Preparation Phase Pilot Phase Implementation 7. Open up purchase of INR denominated debt instruments issued by GoI to All Buyers Open up fully No further restrictions on INR denominated paper for any buyer 8. Restructure budgets/‘balance-sheets’ of states and metropolitan municipal corporations Start Phase-1 Phase-2 Phase-3 Phase-4 Complete 9. Shift burden of future infrastructure financing from public to private sector through PPPs Pilot PPP Projects PPP s in 10 states PPP s in 15 states PPP s in All states 10. Set up independent public debt management office (or as second-best locate it in MoF) De facto shift Independent PDMO Public Debt Managed IndependentlyB. Actions on Monetary Policies and Monetary Management based on Inflation Targeting 11. Focus Monetary Authority exclusively on single task of managing key short-term ‘base rate’ Technical Studies Policy Decisions Implementation of Changeover Separate Regulator 12. Full CAC to be achieved in a time-bound manner within the next 18–24 months Technical Studies Prepare Execute Capital and Current Accounts Fully OpenC. Actions on Financial Regime Governance and Financial System Regulation 13. Improve functioning of Legal System insofar as it affects financial services. Phase 1 Phase 2 Phase 3 Legal System at Global Standard13A. Improve knowledge-skills and training of judges and arbitrators Train 30% of staff Train 65% of staff Train All Staff Continue training/updating13B. Reduce Case Backlog of cases involving financial contract disputes Reduce by 25% Reduce by 50% Reduce by 75% Eliminate Totally 14. Create International Financial Services Appellate Tribunal (IFSAT) covering all of finance. Technical Studies Insurance/Pensions Extend to Banking Extend to all of finance 15. Permit unrestricted entry of well-known global legal firms operating in other IFCs/GFCs Prepare Ground Open up Entry All Global legal firms permitted to operate 16. Permit unrestricted entry of well-known global accounting firms operating in IFCs/GFCs Prepare Ground Open up Entry All Global Accounting firms permitted to operate 17. Dismantle barriers between different financial market segments Except Banking Include banking No further compartmentalisation of finance 18. GoI to prepare ‘exit strategy’ for its withdrawal from the ownership of financial firms Build Consensus Non-bank PSFFS Strong PSBs Weak PSBs All PSFFS 19. GoI to reduce equity stake gradually in all types of public sector financial firms; esp. PSBs Prepare Ground Reduce to <49% Reduce to <33% Reduce to 26% 0 by 2015 20. Shift Financial Regulatory Regime from Rules-Based (RBR) to Principles-Based (PBR) Technical Studies Apply PBR-SEBI Apply PBR-IRDA Apply PBR-BR All PBR 21. Conduct Periodic Regulatory Impact Assessments of the financial regulatory regime. Prepare Ground RIA for Banks RIA -Cap Markets RIA –Others Regular 22. Examine Carefully the Need for changing extant Regulatory Architecture Technical Studies Consolidation to 4 Consolidation to 2? Single Regulator? Unified? 23. Trading platform for sovereign bonds to be moved to exchanges (NSE and BSE) Technical Studies Shift Platform All bond trading to be done on market exchanges 24. Draft new Financial Services Modernisation Act embracing ‘Principles Based Regulation’ Prelim Drafting Consultations Final Draft Table FSMA Bill FSMA24A. FSMA should incorporate redrafted Banking Regulation Act ( BRA) giving banks more flexibility Prelim Drafting Consultations Final Draft Table FSMA Bill FSMA 25. Transfer all regulation/supervision of any type of organised financial trading to SEBI. Technical Studies Execute Transfer All financial market trading supervised by SEBI 26. Distinguish between wholesale and retail markets and use appropriate regulation for each Technical Studies Separate Markets Wholesale and Retail Markets regulated differently 27. Open up immediately to DMA and algorithmic trading Rules Open No bans on DMA and algorithmic trading to be regulated reasonablyD. Actions on Filling the Gaps in ‘Missing Markets’ 28. Create rapidly the Missing BCD Nexus in Indian Capital Markets: R      M  I F C A. Bond Market Technical Studies Shift Platforms Widen and deepen sovereign/corporate bond markets B. Establish Currency trading exchange with a minimum transaction size of INR 10 million Prepare Launch Currency Market operates on NSE/BSE supervised by SEBI C. Derivatives Market: Shift trading in vanilla products (futures, options, swaps) to exchanges Widen Range of Contracts to cover currencies, interest rates, credit default and trade them D. Retain and Expand OTC trading of exotic and tailor-made derivatives. Widen OTC trading Continually expand range of products traded on OTC to global levels E. MoF to review/remove constraints on any financial firm operating in derivatives Technical Study Remove all restrictions/bans other than usual prudential regulations F. Create INR cash settled currency derivatives on exchanges open to all (FIIs). Technical Study Launch range of multi-currency futures, options, swaps for trading
  • 29. HPEC Report on making Mumbai an International Financial Centre: Timelines for Recommended Actions Recommended Actions 2007 by Quarter 2008 by Quarter 2009 by Quarter 2010 by Quarter 2011> 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 YearE. Actions to Strengthen Institutions operating in Indian Financial Markets Technical Remove Encourage Let market drive consolidation and segment integration29. GoI to support emergence of Indian LCFIs to emerge, through M&A and takeovers. Studies Restrictions M&A through financial system Technical Framing of Launch Encourage rapid expansion of WAM with PBR-based regulation by30. GoI to permit Wholesale Asset Management regulated by SEBI (minimum account Rs.10 crores) Study Rules WAM s SEBI Technical Remove Full outsourcing of asset management activities by any financial firm operating31. Remove all impediments to outsourcing of asset management by banks, insurance companies, Study Restrictions in India mutual funds, pension funds, FIIs, hedge funds, etc. Technical Accelerated liberalisation Indian financial system fully open to global participation subject32. GoI to bring forward liberalisation of financial sector in keeping with commitments to WTO Agree- Studies Programme in place to prudential regulation and fitness tests ment on Trade in Financial Services.33. Interim adjustment period of two years for Indian institutions to adapt to global competition. Capacity building by Indian firms Indian financial sector open to foreign competition34. Opening of branches by domestic banks to be decontrolled immediately. All restrictions on branch opening by domestic banks to be removed immediately35. Opening of branches by foreign banks to be decontrolled after one year All restrictions on branch opening by foreign banks to be removed36. Remove immediately all restrictions limiting corporate ownership of banks to 10% Restrictions limiting private corporate ownership of banks to 10% to be removed37. Open up Indian capital markets to entry of hedge funds and alternative investment vehicles Remove all restrictions on entry of hedge funds and AIVs38. Set up range of programmes for development of specialised human capital for the financial industry Set up MSc in Finance and a range of specialised technical training programmesF. Actions to Improve Infrastructure in Mumbai39. Transport Infrastructure: A. Intra-city roads and arterial routes [PPPs ] Phased development and expansion of Mumbai’s road transport capacity B. Coastal Highways and Expressways [PPPs ] Technical Feasibility Studies Tenders Preparation Contracts Construction C. Suburban Railways and new Metro System [PPP ] Technical Feasibility Studies Tenders Contracts Construction D. Water-borne Transport – Ferries/Hydrofoils/Jetfoils [PPPs ] Feasibility Tenders Contracts Facility Construction and Operations E. Increase/upgrade airport and runway capacities Actions already taken for Santa Cruz and Sahar. New plans for Navi Mumbai airport and runways40. PPPs for Power Infrastructure: A. Increase in Power Generation Capacity (24 × 7 × 365) Studies Tenders Contracts Power Plant Construction and Operations B. Increase in Transmission/Distribution Capacity Studies Tenders Contracts T&D Line Construction and Operations41. Water Supply, Sewerage& Drainage: A. Increase in Storage Capacity and Pipelines [PPP ] Plans and Projects underway to increase and improve water supply quantity/availability B. Increase in Filtration and Water Quality [PPP ] Plans and Projects underway to increase and improve water quality C. Upgrading/Expansion of Sewerage Capacity Plans and Projects underway to increase and improve sewerage capacity/treatment D. Upgrading of Storm and Flood Drainage Plans and Projects already underway to increase and improve storm/flood drainage42. Increase Waste Disposal Capacity: For solid and liquid waste with environmental protection Develop PPPs Contracts PPP Contracts Underway and Operating43. Telecommunications Infrastructure: A. Substantial Expansion of Cellular Network TRAI to hold cellular operators to service quality commitments to upgrade continuously B. Expansion of Landlines and Broadband MTNL to expand landlines in keeping with demand growth; increase competition C. Expansion of International Bandwidth VSNL , FLAG to increase bandwidth rapidly; introduce greater foreign competition44. Accommodation: Residential, Office and Commercial Drop ULCRA/RCA Normalise rentals Dispense with all controls except urban planningG. Actions to Improve Urban Governance in Mumbai45. GoM and BMC to appoint or arrange to elect a City Manager accountable for Mumbai Prepare Appoint/Elect Place City Administration under full control of City Manager Groundwork46. Bring the existing city governance machinery under the full control of the City Manager Prepare Groundwork47. Establish independent financial base for the city that is under the control of the City Manager Study Options Agree Fund Sources Place City on mainly independent financial footing48. Rationalise and streamline to organisation structure and lines of responsibility in city management Organisation Study Transition Implement Rationalisation/Streamlining Programme Executive Summary xxxiii