PM Narendra Modi's plan to make a Singapore in Gujarat falls flat

What India lacks is capital, and the preconditions to establish a truly international financial center

By Andy Mukherjee

When Singapore set up an international financial hub in the late 1960s, the city-state was thinking both fast and slow — seizing an immediate opportunity and opening a path to long-term economic development. Half a century later, India is attempting something similar in Prime Minister Narendra Modi’s home state of Gujarat. But without much thought going into what exactly it’s building, for whom and for what purpose, all it may get is a casino for the local rich.

For Singapore, the British pound’s 1967 devaluation was the moment of reckoning. For one thing, it raised the profile of Dick van Oenen, a Dutch trader who had made a “significant windfall” for both his employer — Bank of America — and for the newly independent city-state from that abrupt 14% change. But beyond the immediate cash, Singapore saw a broader canvas.

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The pound’s tumble had made countries in the Sterling Area, mostly former British colonies, painfully aware that the sun had finally set on the empire’s currency: They needed to switch to the dollar to lend and borrow. The kind of rapid growth East Asia then imagined for itself could be more easily financed by inviting the rich overseas Chinese in Hong Kong, Taiwan, Manila and Jakarta to deposit their funds in dollars. Many of them had become extremely wealthy on assured cash flows from post-colonial monopolies and cartels in everything from gaming and racetrack-betting to flour-making and coconut-milling.

Channelling these regional savings into local investments and diversifying the Singapore economy was the longer-term impetus for starting a dollar-denominated banking hub, according to Oxford University historian Catherine Schenk. Bank of America’s local branch was the first to get permission to open a separate set of books purely for international business.

India embarked on the project in 2007 with the ambitious goal of turning Mumbai, the country’s domestic financial capital, into an international hub after making the rupee fully convertible “by no later than the end of calendar 2008.” However, after a 14-year interlude that encompassed both the 2008 subprime crisis and a pandemic, there’s little enthusiasm left for financial globalization. Even trade liberalization, which looked irreversible in 2007, is being undermined by a misguided yearning for self-sufficiency. The venture was yanked away from Mumbai and taken to a patch of wilderness in Gujarat. Somewhere along the way, the original purpose was also lost.

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All new stores need their early patrons. Had India pursued Singapore’s strategy, it would have begun by targeting nonresident Indians to keep some of their wealth with their banks’ branches in the Gujarat International Finance Tec-City — more popularly known as Gift City — luring them with simple products not available commercially in global markets, such as dollar-denominated sovereign Indian bonds. Corporate issuers would have followed. But banks are run by bankers, who need good schools and better pubs. Three high-rise buildings situated 10 kilometers (6.2 miles) from Gandhinagar — the capital of a state where alcohol is prohibited — offer neither.

Since a bank-led approach wasn’t feasible, minders of Modi’s favourite project turned toward capital markets, in the hope that with sufficient inducement brokers would book trades in Gift City without having to set foot there. As a result, the joyless place has spent years trying to become a marketplace for foreign currency-denominated contracts, hoping to capture some of the financial intermediation that now takes place in London, Singapore, Hong Kong or Dubai, but where the ultimate risk resides in India.

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The Gujarat market offers a slew of tax breaks, but has very little customer liquidity. India’s two domestic exchanges — the National Stock Exchange of India Ltd. and BSE Ltd. — are providing costly incentives to intermediaries to trade with one another there. At least 85%-90% of trades at Gift exchanges are proprietary trades, the news website Morning Context recently reported.

Hedge funds aren’t coming. Everything they want for risk mitigation or speculation is available within a one-mile radius in Singapore. To arm-twist investors to come, India’s No. 1 stock exchange even picked a hissy fight with its long-term partner, the Singapore Exchange Ltd. The conflict has since died down, and there’s an agreement on setting up a pipe connecting NSE in Gift City with SGX after ensuring “member readiness.” Meanwhile, the city-state is still trading derivatives linked to Indian indexes and stocks with gusto:

Now comes another strategic wrong turn. Just last week, the central bank allowed resident individuals to open foreign-currency accounts in Gift City to invest in securities issued by overseas firms. This isn’t a step toward the original goal of capital-account convertibility. India already permits all adults and minors an annual $250,000 quota for overseas remittances. Worse, if the money placed in Gift isn’t invested in 15 days, it returns home to a rupee account. Loose change of retail Indian cash parked temporarily in Gujarat is hardly going to entice a pedigreed global issuer to hawk equities or bonds there.

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So who’s this for? Gift allows brokers to pool foreign customers’ money under omnibus accounts. Investors don’t need to register, only the brokers need to be satisfied that they’re legitimate. Even the US Securities and Exchange Commission recently ticked off broker-dealers for not doing enough due diligence on omnibus-account customers to prevent money laundering. The project’s regulator, which isn’t even one year old yet, will have to be on a serious watch against “round-tripping,” or local money escaping to evade taxes and then reentering as overseas investment.

Another plan is to bring trading in non-deliverable forwards — bets on the rupee that aren’t constrained by India’s capital controls because they’re settled in dollars — to Gift by luring overseas investors with tax breaks. This, too, puts the cart before the horse. Among emerging-market NDFs, rupee contracts are the second-most-popular after the South Korean won, with a 19% share of the $250 billion-a-day market, according to a 2019 Bank for International Settlements survey.

The price signals these offshore derivatives emit tend to become a headache for a central bank trying to manage a controlled home currency in times of balance-of-payment stress, like during the 2013 taper tantrum. Rather than wanting these potentially destabilizing flows to come closer home, India ought to be deepening the onshore rupee market in Mumbai instead. It should also be paying more attention to interest-rate derivatives, like Mexico and South Africa have.

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In hosting an international financial center, Singapore stole a march over rival Hong Kong, where the bankers were initially against more competition. But it wasn’t tall buildings that made the experiment a success. A freely convertible currency, pragmatic regulation, a stable tax regime, rule of law and speedy dispute resolution played a huge role. (Good schools and pubs helped, too.)

Opening up after the pandemic, the Indian economy is awash in central bank-sponsored liquidity. What it lacks is capital, and the preconditions to establish a truly international financial center. Gujarat was never the right place to build a global mart. Bereft of any economic logic, Gift may only appeal to the local wealthy shopping for a bit of tax-free dollar riches.