|»5 Minute Wrap Up by Equitymaster|
On This Day - 21 JUNE 2011
Is this 'tax loophole' dooming India's long term prospects?
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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.
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.
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.
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.
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