Sunday, March 1, 2015

Budget 2015: Financial Markets

The Budget makes some proposals to boost the financial markets in India, both in the debt and equity segments, but arguably the reforms are only incremental and many not necessary result in drastic expansion of the markets.

Corporate Bonds

The first proposal is to give a fillip to the bond markets. As a co-author and I have observed in an earlier paper, the equity markets in India have developed much faster and wider than the bond markets, which are lagging far behind. While the equity markets have received substantial support from the Securities and Exchange Board of India (SEBI) as the market regulator, its reforms pertaining to the bond markets have been far from being as successful. This is despite the need for deep bond markets to service the funding needs of specific sectors such as infrastructure. The previous incremental efforts to boost that market did not elicit the anticipated results. Hence, the Budget makes a proposal that the Government will set up a Public Debt Management Agency (PDMA) to bring India’s external borrowing and domestic debt under one roof. More details are awaited on the functioning of this Agency and as to what impact that might likely have on India’s bond markets.

In the aforesaid paper, we argued that mere incremental reforms in the bond markets are insufficient, and wholesale changes are necessary to the legal system, especially when it comes to contract enforcement and an efficient bankruptcy regime, which are necessary to invigorate bond markets. These concerns have been addressed, at least tangentially, given that the Budget considers contract enforcement (dispute resolution) and bankruptcy, as discussed in the post relating to the ease of doing business.

Commodities and Securities Markets

The second set of proposals deals with the regulation of certain aspects of the financial markets and more specifically on investor protection measures. The Budget seeks to merge the Forward Markets Commission (FMC) with SEBI so as to strengthen the regulation of the commodity forward markets and reduce wild speculation. This will result in regulatory consolidation of the forward markets and derivatives trading in both the commodities as well as securities markets. This move is perhaps attributable to the issues faced in the commodities markets due to recent episodes.

Capital Controls

A related proposal pertains to the allocation of regulatory domain over capital controls. Hitherto, the RBI has been exercising primary power over capital controls by virtue of section 6 of the Foreign Exchange Management Act, 1999 (FEMA). Now, the Budget proposes to amend that provision to reallocate the powers between the RBI and the Central Government. Under the new dispensation, RBI will have primary regulatory control over capital account transactions in respect of debt instruments. In case of all other capital account transactions (including equity), the regulatory domain will shift to the Central Government, which will exercise its powers in consultation with the RBI.

This would affect the existing role of the RBI in matters relating to foreign investment on the equity side. Currently, the Government of India lays down the overall policy on foreign investment, while the RBI regulates the foreign exchange flows in connection with such investments. Now that the entire domain over foreign investment and foreign exchange are to be located in the Central Government, the RBI would cease to exercise control over foreign investments in equity. While this will affect the exercise of powers of RBI as an independent regulator, at a practical level it might end up streamlining the foreign investment process. As observed in an analysis on this change, currently there are often mismatches in the regulatory supervision because often the Central Government announces changes in foreign investment policies, but they are not followed up by the RBI through a change in its regulations until much later, which leads to incongruities in the interim. Going forward, these issues are likely to be settled as the Central Government will be the single regulator for capital account transactions (except for debt instrument).

As for debt instruments, the RBI would continue to exercise domain over those. The types of instruments that would constitute debt will be determined by the Central Government consultation with the RBI, but one may surmise that it would include instruments such as corporate bonds and other forms of external commercial borrowings (ECBs).

Other Matters

The Budget proposes the establishment of a Financial Redressal Agency that will address the grievances of consumers of all financial services providers.  More details are awaited.

Finally, the Indian Financial Code is likely to be introduced in the Parliament soon, which is pursuant to the recommendations of the Justice Srikrishna Committee.

Overall, the Budget proposals relating to the financial markets are incremental in nature, which would help to boost the markets. However, there appear to be no radical reforms as such.

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