MUMBAI (Reuters) - India, whose protected financial sector helped insulate it from the worst of the global economic meltdown, should not be complacent in its push for financial sector reforms, a top Bank of America-Merrill Lynch (BAC.N) executive said on Monday.
“One thing that does worry me is that the conservative nature of Indian regulation. That may persist longer than it would otherwise have done because of the financial crisis,” said Kevan Watts, who heads the combined Indian operations of Bank of America and Merrill Lynch.
The rousing re-election of the Congress party-led government in May, which freed it from dependence on communist allies, lifted hopes of an acceleration in long-delayed financial reforms.
But the global financial meltdown has dampened Indian appetite for financial liberalization, especially as limits on foreign banks and active regulation of the financial sector were seen as sheltering it from the worst of the downturn.
“The danger is, that if you like, India will rest on its laurels of having circumvented the crisis well,” Watts told the Reuters India Investment Summit in Mumbai.
India has for years talked about allowing a greater role for foreign banks and giving equal voting rights to foreigners in private-sector banks, currently limited to 10 percent irrespective of their actual holding.
No foreign firm is allowed to operate in the pension sector and private Indian players have only a limited presence.
The life insurance market was opened nine years ago, but companies are not allowed to raise debt or go public in their first decade of operation, putting the onus on shareholders to fund costlier growth.
Foreign ownership in the life insurance sector is capped at 26 percent.
Watts said financial reforms could help India’s large savings to make its way into productive investments.
India has about $400 billion in domestic savings, but little is funneled through the banking channel currently to fund, for example, the country’s huge requirements to build infrastructure.
Watts, who has spent nearly three decades with Merrill Lynch and has been based in India for about 18 months, said swings in foreign capital flows were a concern, but taxing them was not a solution.
“I think volatility of fund flows is certainly something I would be worrying about if I was advising the government,” said Watts, who early in his career worked for the British treasury.
“When you start taxing things, there are a lot of unintended consequences,” the Oxford alumnus said, adding, “Critically for India, any unilateral move of that kind would really damage its reputation globally.”
He said India should instead use existing mechanisms, such as sterilizing inflows by issuing special bonds. India’s central bank has in the past used market intervention bonds to absorb excess liquidity generated by large foreign capital inflows.
Foreign investors have so far bought more than $15 billion of local equities in 2009, after selling $13 billion in 2008, helping send Indian stocks up about 75 percent and lifting the rupee to its highest in more than a year.
The capital inflows are part of a trend globally that is seeing investors chasing faster growing emerging markets, given sluggish recovery and low interest rates in developed economies.
This has raised concerns inflows may create asset price bubbles and drive currencies to uncompetitive levels. That has prompted some economies, including Brazil and Taiwan, to impose controls and others, such as Russia, to say they were considering such steps.
Watts said India should also encourage more domestic participation in its equity markets to counter the impact of foreign investment flows.
Indian institutional investors lack muscle to counter rapid fund flows. For instance, government pension funds are not allowed to invest in equities, while investment by private pension funds is limited to just 5 percent of their assets.
Financial reform is “not about whether foreigners can own 49 percent of life insurance joint ventures or 26 percent,” he said. “Perhaps the most important thing that the Indian government can do is to encourage the further development of domestic Indian institutional investors,” he said.
Editing by Jean Yoon