Is India really serious about attracting foreign investment? - Straight from the Hip by J Mulraj
Investing in India - Straight from the Hip by J Mulraj
Is India really serious about attracting foreign investment? A  A  A

18 MAY 2013

Finance Minister P Chidambaram has made several trips overseas to tell foreign investors that India is serious about attracting them to invest here. He has at least one convert, George Osborne, the Chancellor of the Exchequer in Britain, who maintains that Chidambaram is doing an excellent job.

But, as the saying goes, actions speak louder than words, and some official action belie the claim that we are serious in our effort to seek foreign investment. The most celebrated is the retrospective amendment made in order to collect capital gains tax (which is paid by a seller, who makes the gain) from the buyer (viz. Vodafone) on the ground that the buyer ought to have deducted the tax prior to making payment for the controlling interest to the seller, and deposited it with the Government. The retrospective amendment was made after the Government lost the case in the Supreme Court, and as a clarificatory amendment, to clarify the stance the Government states it always held, viz that it is the buyer's duty to deduct the tax on the gain at source, and deposit it with the Government.

The dispute would go, as all international disputes do, into arbitration, a long drawn and uncertain process. Which is why Kapil Sibal, who holds temporary charge of the Law Ministry after Ashwani Kumar was, ahem, removed, almost immediately on assuming office, progressed an out of court settlement with Vodafone. Given the uncertainty that sorrounds the sector, once considered the blue eyed boy of the success of economic reforms, such a move ought to be welcomed.

We, in India, have a habit of shooting ourselves in the foot. The move towards an out of court settlement led to an allegation of a conflict of interest because Kapil Sibal's son, Amit, had once represented Vodafone. Amit says there is no conflict of interest and that he has not, for the past 3 years since his father became the Telecom Minister, represented any telecom company.

That said, the Government is going about cleaning up its own mess in telecom, in a strange way. It has threatened Vodafone with a non-extension of its licence, when it expires in 2014, never mind that Vodafone has invested humungous amounts of money in the business and has millions of customers. The Government insists Vodafone bid in spectrum auctions, for which it sets the reserve price to be commercially far too high. Vodafone has gone to court. Last week Bharti Airtel and Loop also went to court, seeking that their metro licences also be extended when they expire in 2014. Norwegian telco Telenor, says that it will merge with an Indian company, but only after clarity on several issues.

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So if we wish to revive the telecom sector and to attract foreign investment, we must get real and resolve all doubts in the minds of telecom companies on various issues. The Government cannot threaten them with non extension of licences and force them to bid for spectrum at commercially unviable reserve prices.

Another bewildering decision is to slap Shell with a Rs 15,000 crores demand for tax, under transfer pricing laws. The parent invested in its wholly owned subsidiary at par, a price the Income Tax Department felt was too low, and went on to tax the difference as a gain to the parent. This column had covered the point earlier. Last week the Attorney General accepted the contention of the IT Department. Obviously Shell is chagrined, and has gone to court. The sale of shares by the subsidiary is a capital receipt, not a revenue receipt; there is no justification for taxing it. Meanwhile China, which has not made any such ludicrous and untenable claim, has seen a $ 100b. investment by Shell in developing its shale oil and gas fields.

The function of Government is to ease and facilitate industry, trade and commerce, because these provide the economic growth and the welfare of the people. The State of Maharashtra is involved in a dispute with the trading community, over the introduction of a new tax, viz LBT (local body tax) which is meant to replace octroi, levied upon goods entering the state. The traders are not against the tax but are against the provisions that make them exposed to harassment and corruption. There are several such provisions. Like, for example, the power to the Commissioner to determine whether the sale price of any good is fair or not. This would be retrograde, reminiscent of the licence permit raaj, and would deter development of industry and trade in Maharashtra. The traders want LBT to merge with GST, as has been done in other states, and which does not give local authorities arbitrary policing and inspection powers, leading to corruption.

But Governments of other countries are equally adept at poor governance. Take the case of US mortgage lender, Fannie Mae. It had collapsed in the 2008 financial meltdown, and was rescued by a massive financial injection by the US Government. It has now made a $ 59 b. book profit (surprise, surprise!!) and will be paying a dividend to the US Government, which is the majority shareholder, as part of the bail out package.

Now here is the funny part. Of the $59 b. profit, as much as $ 55 b. comes from an accounting entry, because Fannie Mae had tax credits it could not avail of due to lack of profits. Since it is an accounting entry, Fannie Mae does not have the cash to pay the dividend to the Government, and has borrowed it! This is accounting insanity as its best.

Far more scary for everyone is the way banks are protected. As per this post, no bank deposit is safe. When they deposit money in a bank, the money belongs to the bank, and the depositor becomes a creditor of the bank, with a right to claim his money back. He is an unsecured creditor. In the event of a bank failure, the rights of an unsecured creditor is below the rights of a secured creditor (like bond holders). This is why Cypriot banks were legally entitled to shave off 40% of large deposit holder's deposits, overnight.

As Bill Bonner points out on this site, in his post 'Where did the US $700 b. go?' the funds provided under TARP, ostensibly for bankers to lend to customers in order to get the economy moving again, is untraceable. It has, essentially, gone into purchase of assets, creating potential bubbles.

Now Japan is pump priming, with a kitty of $ 1 trillion. Less of this money is going into lending to industry, to invest, and to consumers, to spend, and more of it is going into assets. Stock markets are booming.

Last week the market showed the power of this excess liquidity.

On Monday, the sensex fell 430 points, on news of a widened trade deficit in April. Thanks to higher imports of gold, after prices fell. Strangely, S R Rao, Commerce Secretary, found higher imports unexpected!! The basic theory of economics is that demand goes up when prices fall, and vice versa (except for some things like crude oil, where demand is inelastic). However, the fall was shortlived, as increased liquidity drove money back into stockmarkets. So when, two days later, there was positive news on inflation, the sensex bounced 490 points, more than making up the first day fall. Such volatility will be the norm, going forward.

The BSE-Sensex closed the week at 20,286, for a gain of 164 points, and the NSE-Nifty ended at 6,187, for a gain of 80 points.

S&P has retained India's rating at BBB - with a negative outlook, which essentially means a one in three chance of a downgrade. Instead of being miffed about it, as Indian policy makers are, they ought to introspect. Granted, they are unused to introspection and more given to pompous complacency about the absolute correctness of their own views. Else why would they be so unwelcoming of much needed foreign investment?

C. Rangarajan, the PMs Economic Advisor, says that India's imports of gold must be curbed. He ought to take some time to understand the lure of gold. There would be a variety of reasons, including distrust in other forms of investment. Bank deposits do not give a return higher than inflation, and are value erosive. If, on top of that, they run the risk of a Cyprus like haircut, in order to protect the interest of secured lenders, then, perhaps, the lure of gold is enhanced.

Stockmarket investing is not easy either, especially in smaller towns or even villages, where there is no means to access them. The growth of the mutual fund industry has been stymied after the commission structure to marketing agents was changed, disincentivising them. Also more than half of Indians do not have access to banks because it is unviable for brick and mortar bank branches to be set up there. Mobile banking is a solution but we have run into the wall of security concerns.

The demand for gold would be curbed if we provide alternative investments which are safe and rewarding, and provide access to these in remote areas. By simply imposing curbs on gold imports, or hiking import duties, demand for gold will not slacken; the imports would then become clandestine. This will give more power to criminals.

To improve the country's ratings a lot of common-sensical steps need to be taken. Such as the approval, last week, by Kapil Sibal, to have options in M&A and PE deals.

If this, or the next, Government, can continue making common sensical decisions, the rally will sustain. If this, or the next, Government, continue to lord it over the universe, believing that theirs is the only correct analysis of a situation, then the market will be volatile, falling sharply with every scandal or misstep and bouncing back with every bit of positive news. The electorate has been continually showing that it cares about good governance. It punishes parties who are seen to be incompetent or corrupt, and rewards those, through re-election, which deliver economic growth. Have politicians got this message yet?

J Mulraj is a stock market columnist and observer of long standing. His weekly column on stock markets has run for over 27 years. An MBA from IIM Calcutta, he has been a member of the BSE. He is Conference Head - India, for Euromoney. A keen observer of events and trends, he writes in a lucid yet readable style and takes up issues on behalf of the individual investor. Nothing pleases him more than a reader who confesses having no interest in stock markets yet being a reader of his columns. His other interests include reading, both fiction and non-fiction, bridge, snooker and chess.

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10 Responses to "Is India really serious about attracting foreign investment?"
mr.saber elfaidy
Jul 2, 2014
mr.saber elfaidy is top financeial freedom 21 censury education partner and stuff in all world Like 
mr.saber elfaidy
Jul 2, 2014
mr.saber elfaidy is top financeial freedom 21 censury education partner and stuff in all world Like 
J Mulraj
May 20, 2013
Thank you, readers, for your comments.

Mr Apte, the seller in the case of Vodafone was not Essar but Hong Kong based Hutchison.

For invesstments in India, foreign companies set up a holding company, abroad, and the holding company invests in the Indian subsidiary. When the foreign company wishes to exit from the investment, it sells the shares of the holding company to the buyer. The transaction is treated as a sale of shares, and because it is offshore, it does not come under the purview of tax.

This was how sale transactions were being done until Vodafone. It is the size of the Vodafone transaction, combined with the size of India's fiscal deficit, that brought this modus operandi under greater scrutiny.

The Government of India is arguing that, although the sale is one of shares, the underlying assets reside in India. Since these assets have enjoyed all the infrastructure, and the market, that India offers, the sale of the assets should bear their share of tax.

It is a fair argument, and the Government has a point on which to argue.

The Government argues that it had informed Vodafone of its (the Government's) intention to collect tax on this transaction, and had asked Vodafone to deduct the tax amount at source, and to deposit it with the Government.

This is because it is easier for the Government to collect the amount from an entity based in India, with hard assets in India, than to collect it from an entity like Hutchison, based in Hong Kong.

The point, according to me, which will be important is - whether the Government had properly communicated its intention to collect the tax from Vodafone and whether Vodafone was obligated to deduct it at source before making payment to Hutchison. Would Hutchison have accepted this, or refused the transaction?

The retrospective amendment to the law was made to clarify the Government intent, in future transactions, that the buyer of shares in an Indian entity, must deduct tax at source even if the transaction is consummated internationally.

What the Government ought to consider are two things:

1. whether the decision in international arbitration would go in its favour, or not. There are points of law on both sides and the matter would go into prolonged and uncertain arbitration proceedings. So, is it wiser to compromise?

2. has the Government sent foreign companies and investors a wrong signal by making a retrospective amendment to the law, after losing a case in the Supreme Court? If so, is it wiser to compromise?

To me, the above two points sum up the current situation. Warm regards Jawahir Mulraj
May 19, 2013
The only message the Indian government has succeeded in giving the rest of the world is--"hey! come and invest in India and generate profits.We know how to steal it and we must as we have a huge hole in our fiscal balance sheet to fill.If you refuse to pay,we'll wrap you up in endless litigation." Like 
Sudhir Apte
May 19, 2013
Mr Mulraj I am an old fan of yours since your TOI days. Regarding Vodafone case one aspect is bugging me. Pl. spare some time to clear my doubts. The tax is payable by the seller which probably is Essar. Vodafone made a technical error and didnt deduct tax at source. But eventual liability is Essar's. Why the govt and Vodafone are not trying to recover this amount from Essar? How come Essar is not in the picture at all ? A reply will be greately appreciated. Like 
chandra shekhar sood
May 19, 2013
a highly realistic commentary on the state of politics and governance in the country; but, who cares! those responsible for governing the country and watching after the well being of citizens are busy filling their own pockets. more the scandals, the more they profit. why would they take the trouble of doing the right things when it would not pay them? Like 
Anupam Garg
May 18, 2013
the writer's straight and direct critical analysis of government's mistakes is worthy of applause

takes some guts to go after the politicians' idiotic actions on a weekly basis

May 18, 2013
I am afraid there is little hope for India's growth story--genuflection apart--so long as Chiddu remains the Finance Minister. Why? Because he brings to bear a policeman's approach into matters of serious economic import. No doubt, he is great in policing economic activity, not in promoting it. His pathetic efforts at reform have fizzled because he makes things so complicated to plug loopholes as to make them unworkable.
But 10 Janpath loves him for this negativism. Increases the number of supplicants for being assisted!!!
Dr R Kapur
May 18, 2013
As always Mulraj rights sensibly. GOI is trying to follow the logic of USA in some ways. Amidst all the debate on Vodaphone tax issue I wonder why the seller has not been taxed as he earned the profit? Vodaphone also knew of the legal provision - the spirit behind the law - but chose to evade its responsibility through a legal loophole. Now the govt is hell bent on Killing the Goose that laid the Golden Egg - Telecom sector. Like 
May 18, 2013
Though Indian Businessmen are really interested in attracting foreign investments, the Government and the ruling politicians are not paving a good road for the investors and enterprising entrepreneurs. This is well known to them but they are not able to curtail the differences between them and get all compromises regarding the monster corruption. Like 
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