GATS and Financial Sector Reforms: Future Agenda
Dr A K Sen Gupta

There is no doubt that financial sector plays an important role towards growth and development of an economy through facilitating rate of savings as well as efficiency of production. There has always, therefore, been an attempt by developed countries to induce increased liberalization and opening up of the financial system of their developing counterparts so that it can help them play a dominating role in markets of the latter. With conclusion of the negotiations under GATS in respect of financial services in 1997 to be operative since 1999, there have been remarkable commitments given by various developing countries in terms of opening of their financial sector. India has been no exception. However, the obligations of the Government of India have primarily been in the area of market access and limited to the sub-sectors of banking and insurance.  In the banking sector the major commitments have been allowing the foreign banks increased licenses progressively from 8 to 12 per year with an upper cap of 15 per cent of the total banking assets. There is also a binding that operations will be allowed only through branches (and not through subsidiaries). In respect of insurance there has been no commitment under life insurance. The commitment is primarily in the area of reinsurance / retrocession and foreign insurance brokers. For all other sectors the commitment is restricted to foreign equity participation maximum up to 51 per cent.

So far, so good. If one looks at the commitments as above in absolute terms as well as in comparison to other developing countries in South-Asia or Africa or South –America, it appears that India is fairly well placed and there are apparently no issues. But one needs to look beyond the paper commitments and understand deeply the context of opening in terms of GATS. The obligations under GATS can be given either under request of a counter-party (other country) or suo moto through a route known as “Automatic Liberalization (AL)”. This means that a country can liberalize a sector of its own choice without giving any specific binding under GATS. The advantage of this route is that the country can always reverse its path. The problem lies that a country can go on liberalizing its domestic front without being open and transparent. This, therefore, becomes a more convenient route of liberalization. India has adopted the route of AL quite often in the context of service sector with particular reference to financial services. For example, against the official commitment of 12 new branches per year, the Reserve Bank of India has allowed around 15 foreign bank branches during last few years. Though officially there is no opening up of the insurance sector (under commitment to GATS), foreign equity participation up to 26 per cent is allowed in the insurance sector with several new players coming on the scene during last few years. Similar is the case with investment banks or mutual funds where 100 per cent equity participation is allowed without officially giving any commitment. In fact the Indian financial markets today are more open than some of the OECD countries, leave alone the developing countries.

The results are visibly being felt. First, foreign players are progressively becoming larger and more powerful players. This is more prominent in insurance than the banking sector. Within 3 years of opening up, the joint venture insurance companies have already jacked up their market share to around 10 per cent. And the trend is perceptible that they are increasingly capturing more market share. Similarly, smaller Indian merchant / investment banks are slowly becoming irrelevant as the larger IPOs and ADRs / GDRs are being lead managed by either the foreign players or Indian joint ventures. Barring some big players like SBI Capital and ICICI Securities, all other Indian players are slowly becoming irrelevant or niche players or playing secondary role to the foreign operators. Second, the financial market in near future is likely to face shake-outs as a result of mergers / take overs, etc. The main casualties in this regard are again going to be Indian players who would lose out the battle to their stronger foreign counterparts. India should learn lessons from experience of the South American financial sector that saw a dramatic transformation during the decade of 1990s. For example, the share of assets of foreign banks in Argentina and Brazil went up from 6 & 10 per cent to 23 & 49 per cent respectively during the period from 1990 to 2000.  Number of mergers involving foreign banks in countries like Brazil and Colombia during 2 year period from 1997 to 1999 was as high as 38 & 11 respectively. Third, India does not have either any specific provision under Emergency Safeguard Measures as provided under GATS or adequate Competition Law as a result of which the country might face difficulty in case of a financial crisis as happened to some South-Asian countries in the decade of 1990s. The adequacy of foreign exchange reserve might not help as it will take days for it to wither away. Fourth, there has been some positive impact as well; the Indian players have appreciated that there is no going back from the liberalized regime. In future, the market may get further globalized. The answer to the problem obviously lies in becoming globally competitive benchmarking with the internationally accepted practices. ICICI Bank, HDFC Bank are some examples that are trying to become global in contour, size and operations. Purely Indian and public sector entities like SBI or LICI have also started thinking globally. The Indian financial market in general is showing signs of maturity with domestic players becoming gradually more competitive. This obviously is a good sign.

Time and again it has been observed that liberalization of financial sector without adequate preparation and proper macro-economic stability and regulatory mechanism may result into catastrophic consequences as happened to several countries of South-East Asia or South America in recent times. There is no denying that the Government of India till now appears to be well prepared and aware of consequences of its acts. Domestic players especially larger ones also seem adequately equipped. What is matter of concern is the presence of large number of smaller players in the various markets of the Indian financial system who are totally unprepared. How they face the challenge remains to be seen. Let them see writing on the wall!

Dr A K Sen Gupta, 
Director,
SIES College of Management studies (SIESCOMS).
The views expressed are his personal.
He can be contacted at sengupta@siescoms.edu.