Unlike just 5 years ago, Indian financial markets are coming of age. So much so, that the finance minister, Mr P Chidambaram, is (correctly) visualising India as a major financial capital.

A very realistic dream. India has a huge natural advantage -- the time zone. Our time zone straddles all the financial markets of the world; we wake up just about the time the Asian markets are getting started, at lunch the European markets open, and more than half the US trading is over by the time we go to bed. Surely the place where a lot of investment banks, etc. would want to set up shop.

Add to it our other cost advantages, especially labour, and you can see how quickly India can achieve the dream. No worry about these jobs going to China since they do not have the time zone advantage. A major financial centre would mean increased employment, increased profits, and higher tax revenue.

So much extra tax revenue that the government can finance even more of its projects to help the poor. An ideal situation, therefore, and one which the Left also should endorse: rich man's taxation to finance poor woman's development.

Other countries, e.g. Germany and Singapore, also see the profits, jobs, and taxes that flow from financial centres, so the race for a major financial centre is well and truly on. Germany has just reformed its tax laws on derivatives, and Singapore changed laws about a year ago. India can compete with them, and steal some revenue. But only if it is willing to change some of its archaic laws (and perhaps even more archaic thinking).

There has to be clear vision and purpose: to reiterate, the objective is to create jobs and maximise tax revenue. Often, such radical goals require a shelving of old assumptions, and even older ideology. For example, it is not the case (especially with "porous" capital markets) that maximising tax rates will create more revenue.

High tax rates make one feel good in socking it to the rich, but the black eye is received by the government itself. The first step for the government is therefore to reform its tax laws. Actually, that is the only step needed -- the markets will soon figure out that India is the happening place.

In July 2004, the UPA government did something radical, a step that has helped create wealth for everybody (including the government). Prior to 2004, short-term capital gains were taxed in India at the normal income tax rate (30 per cent for most investors) and long-term gains were taxed at 20 per cent. While the stock market had been booming, the revenue collected from these high capital gains taxes was minuscule -- a little over Rs 1,000 crore (Rs 10 billion).

The tax reform meant the elimination of the long-term capital gains tax and a reduction in short-term tax rates to 10 per cent. Capital gains taxes have since boomed; in addition, securities transaction taxes have delivered about Rs 3,000 crore (Rs 30 billion) this year (this tax was introduced as a substitute for the capital gains tax).

What does this suggest? Make Indian taxes comparable to the best practices among our competitors in Asia. Eliminate the short-term capital gains tax, and, in exchange, raise the securities transaction tax from 0.1 per cent to 0.15 per cent. And then announce that such taxes would not be touched, at least in the foreseeable future.

There is one other aspect of our tax policy that needs to be changed: the policy on taxing derivatives. Consider the following: if you buy Infosys [Get Quote] shares today, and sell them tomorrow, you pay 10 per cent capital gains tax. If you buy futures in Infosys today, and sell them tomorrow, you pay 33 per cent tax.

Why? Because transactions in derivatives are treated as "business income" while transactions in stocks are capital gains income. How do other countries treat profits from derivatives? First, derivatives, if used for hedging purposes, are not taxed at all.

Second, non-hedging derivative transactions are taxed at the same rate as short-term capital gains tax. There is a third way, a path increasingly being followed. Since the identification of hedging is difficult, countries now opt for a short-term tax of zero (e.g. Korea, Taiwan), or very small, e.g. Singapore taxes such gains at 5 per cent.

Now the Mauritius authorities would be the most upset by this decision, and it is likely that they will lobby extra hard to keep Indian tax rates high. Mauritius and Singapore stand to lose from this policy; India stands to gain.

There are also some cumbersome procedural rules that need to be changed to make the financial centre vision a reality. Financial market jobs for Indians cannot happen unless Indians are allowed to manage foreign money.

Over $10 billion of FII money came in last year alone, and none of it was managed by an India-based Indian. How come? Tucked away in the archives of Sebi policy is a googly more destructive than Shoaib Akhtar's pace: Indians shall not be allowed to manage foreign money. Translated into politically incorrect terms, the Sebi rule is that a white man cannot profit from brown equities via a brown manager; he has to invest via a white man (FII) in order to do so.