As individuals, we tend to introspect around birthdays and other significant personal occasions, or around the year end; as a country, an impending budget tends to serve as end; as a country, an impending budget tends to serve as a catalyst for stock taking. Reflecting on the Indian financial services landscape as we approach the 2011 edition of the bud- get, there are a few aspects which in my mind warrant comment. A significant theme for the next many years to come will be India's infrastructure needs and the investment that this will re- quire. The 12th Five-Year Plan (2013-17) projects an infrastructure spend of over $900 billion (`40.7 trillion), averaging around 10% of gross domestic product (GDP) in each Plan year. Projections suggest that India will experience a funding gap of approximately $285 billion, of which over $200 billion will need to be funded by way of debt. Bridging this gap will require a number of policy initiatives. The domestic bond market needs to be deepened and strengthened, and banks, infrastructure non- banking financial companies (NBFCs) and insurance companies should be enabled to direct funds whether by way of investments or lending to infrastructure projects more efficiently and effectively. Large sections of the institutional market (viz. provident funds, insurance companies) are prevented from investing in below AA rated bonds. Internationally, such bonds could be credit-enhanced by specialist institutions and would then be- come eligible investments; a policy framework is required for such institutions to be established and/or for banks to be per- mitted to provide such credit enhancement. Investments by banks in infrastructure bonds could be exempted from statutory reserve requirements; banks could also be permitted to issue infrastructure bonds, and the liability could be excluded in computing reserve requirements. Insurance companies could be permitted to invest in SPVs (special purpose vehicles) for infra- structure projects, debentures issued by private limited companies and non-dividend paying companies engaged in the infra- structure sector by having such investments included as “approved investments“. In 2010, the government permitted certain institutions to issue tax free infrastructure bonds--the list of eligible entities could be expanded to include banks. The cost of raising such funds also requires rationalization--stamp duty on corporate bonds is approximately 37 basis points; further, the rate varies across states. Interest on foreign currency borrowings is liable to tax at 20%. Interest on qualifying foreign currency borrowings was exempt in the past but the exemption has since been withdrawn; the government should consider exempting foreign currency borrowing for infrastructure or otherwise lowering the rate of tax from its current level. The banking industry structure could potentially undergo material change underpinned by two impending decisions of the Reserve Bank of India (RBI). New private sector banks may be licensed after a gap of seven years. While various licensing criteria, e.g., promoter qualifications and minimum capital requirements are yet to be formally announced, there is an expectation that at least five-six new banks will be established in the relatively near term. A potentially more material development is a discussion paper published by RBI proposing that foreign banks, which at present operate through a branch presence, convert these branches into wholly owned subsidiaries. Among other things, the RBI paper suggests that such subsidiaries would be freely permitted to establish branches in locations other than tier I and tier II cities. For some foreign banks with aggressive plans to build a large branch net- work, this proposal, if implemented, could provide a basis for significant expansion in India. But as is characteristic of much of our policy formulation process, the RBI paper does not discuss implications of its proposals in the context of other regulations, namely, the tax implications upon a conversion of a foreign bank branch into a subsidiary, or the implications under India's foreign direct investment policy, which caps foreign ownership of banks at 74%. Beyond this, and as the UID (unique identification) project gains momentum, banking services could become accessible to a vast number of people, who are excluded from the formal financial services sector. And an enabling framework for mobile banking would go towards further transforming the banking landscape. A closing word on regulations. In its report of July, the working group on foreign investment set up by the ministry of finance devoted an entire chapter to legal process. Beyond the legislation in the form of the Act and the associated rules, regulations governing or affecting the financial sector are contained in circulars, master circulars, press notes and FAQs. For instance, residents are permitted to remit up to $200,000 annually for practically any purpose, subject to certain limitations prescribed by RBI.
This is codified in Fema (Foreign Exchange Management Act) regulations. In a recent set of FAQs issued by RBI, it was clarified that amounts could not be remitted to establish a company overseas. The FAQs do not explicitly form part of the regulations, creating undue interpretation hazard. The group noted that the process of framing and administering regulations requires significant strengthening, that due process must be followed in framing regulations, that administration must be even handed and non-discriminating, and all decisions of regulators should be capable of being subject to judicial review. These tenets and principles ought to guide the efforts of the Financial Sector Legislative Reforms Commission to be constituted by the government to re- view and revamp financial sector regulations. Introspection and stock taking invariably culminates in an agenda for action. While most of the above has very little to do with Budget 2011, there is clearly much for the government to act upon.
(Source - mintlive)
