Under the Narendra Modi-led government, the financial services sector—this term includes banking, insurance, securities-dealing and funds management—will be required to play a dual role going forward. First, as a lubricant for the high rate of growth that the government is aiming for, and second, as also an engine of the same growth.

As a lubricant of high growth, the sector will have to change, as well as lead the change that will be required for the economy going forward. We can expect to see greater use of quasi-equity or mezzanine capital, greater use of loans with floating-rates linked to the cost of capital instead of fixed rates—to make it feasible for banks to provide long-term finance for infrastructure (America was built on 30-year money—availability of venture debt for early-stage companies (a la the Silicon Valley Bank), and the harnessing of technology for efficient, affordable and inclusive banking. I have come across innovative entrepreneurs serving migrant Indian labour through technology.

As for the financial sector’s role of a growth engine, I have been a strong advocate of creating an international financial services centre (IFSC) in India. An IFSC in India would serve three objectives. One, it will serve the Indian diaspora by offering them a place to accumulate savings in a safe well-regulated environment—a place with contemporary technology and expertise to invest their savings, and a place that is politically stable and well-governed—to pass on their wealth to their successors. Two, it will create more jobs in India, and three, it will generate additional revenues for India.

As a service to the Indian diaspora, consider this: India had to airlift overnight thousands of its hard-working citizens from the troubled environments in Libya and Iraq, many of whom lost all their savings. We have over $70 billion being remitted to India annually from NRIs such as the 1.8 million citizens working in Saudi Arabia, the 1.75 million in UAE, 550,000 in Qatar, 350,000 in Bahrain, 670,000 in Oman and the 580,000 in Kuwait. These have been stable environments so far. Therefore, the diaspora tends to accumulate their savings in the local banks; NRE/FCNR accounts offered by banks in India can be operated only under great constraints. The “non-doms” in London work in the UK but keep their savings accounts in the Channel Islands—of course, this is done for tax reasons, whereas many of our NRIs do not have to pay taxes in the countries where they work; but they would all like to keep their savings safe, and an IFSC in India can be a great place. In the 2008 global crisis, many NRIs and other non-residents were very happy to have put money in State Bank of India rather than Citibank.

For creating jobs in India, consider this: Ireland created an IFSC in 1987 to, quote, “create jobs”; it employs 32,700 people directly and contributes 7.8% to the Irish GDP. In Britain, out of 1.1 million employed in the financial services sector, 338,000 work on providing offshore services. By 2009, the sector accounted for 10% of the UK GDP, the highest such measure in all G7 economies. The second-highest was Canada, at 6.7%, and the lowest was Germany at 3.9%. Currently, its share is 12.6% of the GDP in Britain. (Banking plus insurance accounted for 5.9% of the GDP in India in 2013).

The UK financial services sector makes for a relatively higher proportion of the GDP because it also has the highest share of financial services exports in the world, at 29% in 2012. Indeed, the UK generated a record trade surplus of £61 billion in 2013, chiefly from the exports of financial services, almost double that was recorded for Switzerland, the US and Luxembourg, the other countries that recorded big trade surpluses. The value of the financial sector’s exports in the UK, at £83 billion, exceeds three times the
£26 billion spent by tourists visiting the country.

Incidentally, the US offers Delaware as a convenient location for registering companies—945,000 are registered there generating revenues of such a scale that Delaware levies no sales tax. Switzerland manages $2.1 trillion of offshore money, Britain and its Channel/Caribbean islands, $1.9 trillion while Singapore now has $ 1.3 trillion of offshore assets under its care and the US, $0.6 trillion.

Eventually, an IFSC can always specialise—Dublin is popular with companies, Luxembourg with mutual funds. Like the Baltic Exchange for shipping in London, we can create, for instance, an oil-rigs exchange or an exchange for renewable energy products, where suppliers and acquirers can make deals.

We can work towards emulating these developed countries with the new idea of an international financial services centre for export of financial services.

As for the third objective—generating revenues for government—all that this IFSC needs in respect of tax regime is for its non-resident clients to be ringfenced from domestic tax and FEMA regulations—no witholding tax; no capital gains tax; freedom to move money in and out of the IFSC and to invest anywhere. Non-resident Indians, even today, pay no Indian tax on their NRE accounts and invest wherever they choose; other non-residents would disclose their income from the IFSC in their home country. The IFSC would be fully compliant with KYC/money-laundering laws and follow the international best-practices in this regard such as information-exchange agreements. The IFSC would effectively generate tax revenues for government from taxes on incomes of those employed there and the entities operating there.

The Modi government is not only making structural and administrative changes but has also given new directional leads—Clean India, Make-in-India, smart cities, etc. The IFSC would dovetail well with this vision, serve the Indian diaspora, create jobs in India and generate revenues for the government. Thus, it can be an engine of growth.

By Pradip Shah
The author is chairman, IndAsia Fund Advisors Pvt. Ltd, Mumbai