Is India taking a lead from China in developing a new breed of nearshore-offshore financial centers?

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The inauguration of the new India International Exchange (INX) on January 9, 2017 by India’s Prime Minister Modi in a new finance zone, the Gujarat International Finance Tec-City or GIFT city, heralds the possible beginning of a new era in offshore financial centers in Asia.

The current PM envisioned the finance zone when he was the chief minister of Gujarat state in 2008. A similar venture is being planned in the Qianhai financial district in China, slated to be completed by 2020. Like Qianhai, GIFT city is seen as a zone where the country’s financial services regulators can experiment with different policies and products before these are introduced in the financial centers of Shanghai and Mumbai respectively.

INX is owned by the oldest exchange in Asia, the Bombay Stock Exchange (BSE). It will start equity derivatives trading on January 16. It is touted as having one of the fastest matching engines globally, and expected to attract derivatives business from India that would otherwise go to offshore financial centers such as Singapore, Dubai, Hong Kong or London. This business is currently valued at US$48 billion and is expected to rise to US$120 billion by 2025. Eventually, it is expected to offer products such as equity, currency and commodity derivatives, foreign currency loans, structured products and depository receipts. The leading Indian exchange, the National Stock Exchange of India (NSE) is also expected to open its new exchange, NSE IFSC, in the coming months. 96 brokerage firms have already registered in GIFT City as well.

Both the Indian and Chinese efforts have ambitious goals. If they succeed, then exchanges and firms in Singapore, Hong Kong and Dubai could lose valuable business. But it is not going to be easy for the new centers to become competitive. The Indian economy is expected to go through a tougher time in 2017. It is recovering from the effect of demonetization and is going to be impacted by the expected protectionist approach of the incoming US President and the post-Brexit UK Government. The struggling European economy, facing the challenges of record youth unemployment and large-scale immigration, is also a difficult export market.

To set up a new financial center at a time like this might not be a very good idea. There are other challenges as well. Retail Indian investors are not allowed to invest directly in the exchanges in GIFT City, to prevent cannibalization of trading in Mumbai. Also, there are concerns about the possible inadequacy of the tax incentives that are being offered in the zone, as well as issues arising from the fact that the Indian rupee is only partially convertible which might constrain the flow of resources in and out of the financial center.

Like India, the Chinese economy is also going through a more challenging time. It has slowed from its record levels of growth, has high levels of corporate debt, and will likely be affected by rising protectionism in its main export markets abroad. A lot of water would have flown under the bridge by the time Qianhai financial zone comes online in 2020, but things might not necessarily get easier. A factor complicating the matters in China is that Hong Kong already serves as an offshore financial center for mainland China. So unlike the Indian case, Qianhai has a firmly entrenched domestic competitor.

Despite the several challenges, these are exciting times for the Indian financial markets. If GIFT city succeeds, it could create the basis for India becoming a more important global financial center than it would be with only Mumbai. A lot of business that flows from the emerging markets in Asia and Africa to London and Hong Kong could be diverted to GIFT city, and over time create an important source of growth, as well as employment and wealth generation.  However, as stated above, this success cannot be taken for granted.  

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