Is this 'tax loophole' dooming India's long term prospects?

Jun 21, 2011

In this issue:
» Brazil tops the US in job creation
» The worst affected from food crisis
» Raising foreign debt gets tougher for India Inc.
» Should India take some 'power' lessons from Nigeria?
» ...and more!

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The policymakers in India are not known to make bold moves. Especially when it comes to taking the guilty to task. While the governments in several developing economies chose to tax excessive short term capital inflows, the Indian authorities chose to keep mum. Only to repent it once the inflation situation got worse. Even now there is enough scope to filter out short term hot money from flowing into Indian markets. However, diplomatic relations and age old treaties have kept their hands tied. The temporary market reaction to the proposal of levying tax on capital flowing in from Mauritius funds seems to have caused more jitters than a runaway inflation or food crisis.

As much as 40% of the total foreign funds coming into India are routed through Mauritius, given its tax haven status. India retains the right to tax capital gains from non-residents under its tax treaties with most countries. Mauritius is an exception. Under the treaty, only Mauritius has the right to tax such gains. But it does not levy any tax according to its domestic laws. As a result, a Mauritius-based investor does not pay capital gains tax either in India or in Mauritius.

The government's or the central bank's views do not differ from ours when it comes to the inefficacy of FII (foreign institutional investor) money. Such funds are known to bring in unwanted volatility in markets and give rise to asset bubbles. Every now and then regulators like the RBI and the SEBI have also pointed out the negative effects of money coming in through this route. But at a time when there is scope to nip the problem at its bud, the Indian government prefers to stick to its inert mode. Levying capital gains tax on short term funds routed through Mauritius may dissuade few investors. But the level of credibility that the long term money coming in through this route will earn can certainly boost investor sentiment. True that this could lead to some short term hiccups in market sentiment. But we wonder if we can do without that to put things in order for the longer term. Meanwhile retail investors need to keep their portfolio resilient to short term shocks by keeping a close eye on fundamentals and valuations.

Do you think the government should levy capital gains tax on short term funds routed to India through Mauritius? Share your comments with us or post your views on our Facebook page.

 Chart of the day
If you think that the food crisis in India is overrated, you are not alone. Most readers may consider the problem to be one amongst many that the underprivileged class in a developing economy faces anyways. But as today's chart shows, India is close on the heels of some of the smaller economies in South Africa and Asia, when it comes to the gravity of food crisis. This is because of the high spending that an average Indian household has on food items. If the food prices keep spiraling the way they have over the past few months, India's consumption story could be severely hit.

Source: Businessinsider

As is the case with many of Indian state-run utilities, the Nigerian power companies have been run very inefficiently. Low capacity utilisation rates coupled with poor maintenance have left the companies burdening heavy losses. Finally, the government of Nigeria has decided to privatise 18 of its power generation and distribution companies.

The interesting part is that at least 12 Indian companies have been shortlisted by the Nigerian government to participate in the privatisation of Nigerian power companies. This is definitely a great chance for Indian companies to tap opportunities abroad. But more than that, this stands as an important lesson for the Indian power sector. Given the fact that the power sector is the backbone of the economy, it will do us good if our government finds a similar way to root out the inefficiencies from the system.

With unemployment rate being as high as 9% in the US, job creation has become a big challenge for the US government. And this has become all the more apparent when you compare the US economy to that of Brazil. It's not that Brazil's has not slowed down either. In fact, for the 12 months ending March 31, Brazil's growth came in at a lower 5.5% as compared to 7.5% growth in the previous year. Despite that the country was able to create 1.17 m new jobs as compared to US' 783,000 jobs. Of course one can argue that Brazil's figure includes farm jobs whereas the US' does not as farm jobs in the US are much less due to technical advances and mechanization. But it still does not do away with the fact that the job scenario in the US is in a very precarious state indeed. Unless Americans have jobs in hand, they will not be willing to spend even if the Fed keeps throwing money at them.

Raising foreign debt may seem like a smart option for firms. This, is especially since domestic rates have sky-rocketed post the RBI's multiple rate hikes over the past year. The base rate at which banks lend to their clients is now around 10%, while globally interest rates are in low single digits.

The RBI is now planning to ask companies to declare their un-hedged positions while raising foreign debt. Large companies which earn money in foreign currencies can have large un-hedged exposures. Hedging helps offset investment losses from a particular currency position. Having un-hedged positions is risky. This can impact the financial strength of the company, and impact repayments to banks, once currency headwinds change. With this move, the RBI can thus monitor how much debt companies are adding on their balance sheets, and make sure they don't suffer from massive exchange losses. We believe that this move is needed especially in light of global uncertainty in the Euro zone and America.

It looks like a continuation of debt crisis drama without a twist. Now that Greek debt has grown faster than the economy, another bailout is on the cards to avoid a default. It is to be noted that a year ago, Greece was offered Euro 110 bn to get through so called 'short term crisis'. The country once again is on the verge of a break down threatening to take the global recovery along with it. No wonder that IMF, the European Union's partner in Euro zone bailouts has adopted a stern tone in its warning to Euro zone. The direct impact of default of economies like Greece and Portugal could be less damaging, thanks to their smaller size. However, we are all too well aware of the spillover impacts that can derail the global economic recovery.

At the same time, the current state of affairs forces us to introspect the decisions taken in the past. The last bailout certainly has not helped. So should more loans be considered for an over indebted country. That's something to ponder over for the policy makers. All they need to make sure is that if they do opt for bailout, a firm commitment to cut public spending comes along.

Backed by strong cues from Asian markets and buying interest in IT, banking and commodity heavyweights, the benchmark indices in the Indian stock market featured amongst the top gainers in Asia today. At the time of writing, the BSE Sensex was trading higher by 131 points. Major Asian indices closed higher, with Hong Kong, Japan and India leading the gainers. Europe has also opened on a positive note.

 Todays' investing mantra
"If you feel you can dance in and out of securities in a way that defeats the inflation tax, I would like to be your broker, but not your partner." - Warren Buffett

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23 Responses to "Is this 'tax loophole' dooming India's long term prospects?"

George Francis M

Jun 21, 2011

Yes India should levy tax on short term money from Mauritius. This is good for our stock Market



Jun 21, 2011




Jun 21, 2011

v, yes you should NEVER invest in stocks to earn quick buck, it never works, stocks was mean to be for owning businesses through shares by large number of people and sharing profits, they was not meant for speculation. Things have become much more broader then this however basic idea remain same.

If you don't own business for few years, how can you expect to make money?. Is there an business which you can buy and make quick bucks in few days and get out, let me know i will do it.

Yes, loop holes must be fixed, it really shouldn't matter if market goes down even by 10%-20%. It will bring down valuation of companies to much sensible levels which will be good for investors, long term investors should not get effected much. example, united spirits, i believe though stock is good but its over value, it will look much attractive at Rs.600.


Onkarnath Adiga

Jun 21, 2011

Surprised, why govt isn't doing? Resident Indians are forced to pay STCG tax.



Jun 21, 2011

certainly YES. but this is not the time. Once the inflation falls,RATE hikes stopped by RBI and economy improves its MUST BE DONE.



Jun 21, 2011

Everybody knows that FDI is stable, long term investment; preferable for Indian economy to FII money. Yet, FII gets all kinds of benefits thru umpteen ways, including treaties like Mauritius.

Why then is GOI & FM intent on favoring FII investments?

The answer is simple. This is the very money of the politicians, bureaucrats, industrialists, movie crowd and so on which is being recycled.

It seems they are not happy enough by looting Indian public money thru tax evasion, Govt funds diversion, selling of precious national assets - incl mining rights and land rights.

They wish to further denude the middle class of their savings by playing thru FII money and that is why the retail participation in share markets is coming down.


r v iyengar

Jun 21, 2011

Since it is an out and out fraudulent transaction, indulged in by dubious Indians,it has to be taxed.



Jun 21, 2011




Jun 21, 2011

It is my belief that a substantial proportion of tax payers believe that the policy makers in India shy away from taking bold steps, not because they have feet of clay but because they connive with the powerful and the wealthy. People know that the FII are not real FIIs but they are actually BRI (Blackmoney Rerouted in India). No documented efforts have beeen made to find out who is actually behind the Mauritius Funds. Lesser said is better. Despite being a large growing democracy and market, global investors have little interest in India, it is only Mauritius that invest in India with predictable volatility!
Jai Ho!



Jun 21, 2011

Eq.Master Team,
I am prompted to cite the adage(rather definition of) a Banker as "One who lends his umbrella and takes it back the moment it starts to rain ??)
Similarly the institutions that play the game of Quick Monetary flows(Inflows into India and the outflows out of India)do not at all contribute anything by way of
VALUE ADDITION by either producing any goods or providing services in the economy with the deployment of such money ?
They only contribute one thing:They add volatility to the market with such inflows and outflows with utter Ease ??
As such the inflows should be taxed on SIMILAR lines as IN STOCK MARKET gains( SHORT-TERM GAINS)
I feel that such short-term flows should be subjected to some sort of entry tax or entry load as well as exit load/cess as it is prevalent in the Mutual Funds ??
What way is it different from the concept of Mutual Funds within the country ??Such holders of Foreign money do not have any stake here except making speculative gains with the deployment of their money ??
In the absence of such a statutory condition imposed on the inflows/outflows of foreignMoney(" HOT MONEY" in search of higher interest rates/returns prevalent here), the huge tides (of foreign money) may pose a real threat to the stability of the entire economy with the fercoity of such tidal WAVES (of foreign money)??

I hasten to conclude !!

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