The architect of India's financial markets: Dr Singh's legacy of reforms

Of the many reforms that Dr Singh led as FM and PM, the transformation of India's securities markets stands out

The late Dr Manmohan Singh has rightly been lauded for his many contributions that fundamentally changed India. Recognising the critical role of a modern securities market in channelling resources into the real economy, he was the architect who designed and laid its foundation.

 

This was not only about the creation of a regulator— the Securities and Exchange Board of India (Sebi) — though that was the most important and difficult part. It was about developing an entire ecosystem with the institutions, laws, and the supporting environment required for a modern market. Like the US nuclear deal later, this reform was a fundamental and decisive paradigm shift, not merely tinkering at the margin.

 

If Indian companies, including tech companies, are poised to do a record number of initial public offerings (IPOs) in India this year, it is because of what began in the early 1990s. That was when Indian industry was coming out of asset-heavy engineering companies and taking the first tentative steps towards earnings-based, tangible asset-light, and human talent-intensive sectors like information technology (IT). This sector relied more on risk capital than debt. As finance minister, Dr Singh used the fallout of the Harshad Mehta scam — primarily linked to the institutional debt markets — to secure Parliamentary approval for an empowered securities market regulator designed to operate at arm’s length from the government.

 

Sebi was enabled by law to issue binding regulations and granted full control over personnel policies to recruit specialists required for this task without requiring approval from the Government of India (GoI). To carry out its mandate, Sebi also required financial resources. Besides an initial loan from the GoI to set itself up, Sebi was authorised to levy fees on regulated entities and generate its own resources to function in an autonomous manner. All these features were hardcoded in the law in a big departure from prior GoI approval and dependence on government grants that typically characterised Indian public agencies.

 

Thus, was born the first modern Indian regulator, distinct and separate from a GoI department, statutorily empowered to autonomously regulate its domain. The 1992 Sebi Act did not contain all the elements of this design, but the basic direction was provided by this legislation, and the critical features of a modern regulator had been incorporated into the law by him by 1995. It is noteworthy that he did not try to reform the existing regulator, namely the Controller of Capital Issues, but chose to create a new institution without the burden of undesirable legacy issues.

 

In parallel, he and his team initiated the creation of institutions and infrastructure needed for the market that Sebi would regulate. The first important constituent of this market was the stock exchange. The then dominant Bombay Stock Exchange (BSE) was a mutual owned by brokers and resistant to reforms that were not in their interest. After an initial, short-lived attempt at reforming BSE, the team began work to set up a new modern exchange.

 

The National Stock Exchange was seeded as a startup by IDBI and was explicitly prohibited from enrolling trading members into its ownership structure. It was registered as a for-profit corporate entity to ensure better corporate governance. The ownership pattern was designed keeping in mind economic incentives and discourage short-term profit maximisation behaviour, allowing NSE to develop as the first successful demutualised, corporate exchange.

 

Gentle readers would also recall the telecom and IT sector breakthroughs of early to mid-1990s, which were completely redefining the nature and character of all markets, including financial markets. Strategic use of the emerging telecom infrastructure and IT led to the NSE becoming a pan-India exchange, making the regional exchanges (most of which were badly run) irrelevant. This, however, required moving away from paper to electronic shares, as well as the electronic movement of money. The former required serious legislative changes and the latter required the computerisation of banks.

 

The Depositories Act, 1996, and the creation of a depository, with a structure similar to that of modern exchanges to avoid conflicts of interest, was the next set of steps that were taken. Here again the same thinking can be seen. A new well-designed and modern depository was the preferred vehicle rather than reforming an existing (public sector) undertaking, which proposed immobilisation of paper shares, as distinct from the more ambitious dematerialisation. The talent spotter in him drew out the visionaries and nation-builders who came from IDBI and engaged in remarkable entrepreneurial innovation and risk-taking to build all these new bodies.

 

In tandem, the Reserve Bank of India led by C Rangarajan gently stepped up the pace of public sector banks’ computerisation. A little later, when the political climate allowed, the RBI licensed many new private sector banks that were technology-driven from birth.

 

With the regulator in place and the necessary infrastructure and institutions established, policymakers turned their attention to increasing the number and diversification of market participants, which was essential for the development of deep markets. Changes to the legal framework to allow foreign institutional investors to participate in the Indian equity markets followed. This was a crucial step as India then did not have big institutional investors experienced in analysing and investing in shares of companies that had little to show in terms of assets, other than business plans and human talent.

 

These foundations laid by him are responsible for India coming up remarkably high on any parameter on the size, depth, regulation, and other metrics that measure the progress of equity markets. Many of the small moves in reforms had started earlier, as far back as 1977. The big change in 1991 was (a) opening up to the world, shedding India’s previous suspicion of foreigners, and (b) embracing finance as the new commanding height of the economy, as opposed to the traditional Indian scepticism towards finance.

 

This journey is now in serious threat of being derailed, and all of us, especially India’s political leadership, need to put our shoulders to the wheel to return to a pro-globalisation, pro-finance stance, and focus on building institutions for the financial system.

 

The author is an honorary senior fellow at the Isaac Centre for Public Policy, and a former civil servant