A finance SEZ

Questions about policies for the GIFT project

It is clear that getting the Gujarat International Finance Tec-City, or GIFT, underway is one of the major priorities for Prime Minister Narendra Modi's government. This is, at least, one of the major takeaways from its recent moves. The Securities and Exchange Board of India, or Sebi, has approved rules on international financial centres, or IFCs. While these are technically broad rules, they are actually focused, since GIFT is the only realistic IFC candidate at the moment. The new rules are relatively relaxed - stock exchanges will be permitted to have lower levels of capital, foreign firms can raise capital in the IFC via various depository receipts and so on. There are now reports that big tax breaks are also in the offing.

This approach - of creating, in essence, a "finance SEZ" - raises many questions, particularly, on how precisely international finance works. Certainly, it could be the case that some activity will move to Ahmedabad. Some expect that the ability to raise cheap foreign-currency funds will encourage intermediaries to set up shop in Ahmedabad, borrow in foreign currency and farm that money out to Indian companies that would like to take advantage of lower global interest rates. This might be an alternative to standard external commercial borrowing. In addition, a reasonable amount of trading in financial instruments based on the value of the rupee takes place in such centres in Singapore and Dubai - some in speculative derivatives and some in order to help trading corporations hedge. Perhaps a little of this can be lured to Gujarat as well, if the after-tax margins are right.

However, the costs should be carefully considered. The kind of tax breaks that would require a shift of such trading could be distortionary domestically if applied only to GIFT. Further, they could have significant implications for the direction of India's tax policy, which is expected to harmonise and rationalise services and corporate direct taxes. Tax break-based special economic zones (SEZs) are known for the many problems they give rise to; they negate the very point of SEZs, which is to introduce a clustering effect. This may work in manufacturing, but less so in finance. After all, in the world of online, hyper-connected finance, location is about regulatory regimes and historical financial strength.

In the end, those backing the idea of GIFT need to ask themselves what they truly want. Do they want it to be, essentially, a little offshore tax haven within the borders of the Union of India? For that is what GIFT seems to be promising - with all the possibilities for arbitrage and tax advantages that the idea implies. And the truth is that even if an offshore tax haven is what the makers of GIFT may wish to create, their ambitions are likely to face many challenges, and GIFT could wind up being a little more than another back office instead of a genuine international centre. The "new" financial centres, such as Dubai or Singapore, have self-consciously set out to be welcoming in terms of lifestyle and social infrastructure to people from all over the world, regardless of the local restrictions of Arab or overseas Chinese culture. Will GIFT have bars? Will it have genuine connections to the broader economy, socially and financially? Without that, it will just be a location for regulatory and tax arbitrage.