Rampant Liquidity is not the Solution

Central Banks around the world are pumping liquidity in their respective economies to stave off the global economy’s recent softening and to prevent the catastrophic situation which has gazed in the eyes of the world leaders courageously.

To revive the economies around the world the prime banks are trying their best to ease the situation by twisting their operations as done by the Federal Bank of Unites States, Open Market Operations undertaken by the Reserve Bank of India, European Central Bank’s bailout proceedings, monetary easing by the Chinese counterparts or the Swiss and Danes printing money as a means of defending their currency targets, each prime lender to the economy is trying to resurrect its economy deftly.

Will just an injection of liquidity in the crucial sectors create a difference? As far as the last half a decade is concerned, the Quantitative Easings or the Stimuli provided by the governments around the world were just short term solutions. And it is echoed in the global economy that the long term prospect of all the major economies is under the suspect. Take a classic example of India: There has been drought of reforms in the economy since 1990s and this is a major concern in the market. Corporates crave for lower cost of funds and liquidity in the market, which can not only be possible by the OMOs or by unexpected rate cuts but it can only be possible through gigantic reforms which are now a must in the country. Fundamental issues like Foreign Direct Investment in Retail and Aviation has to given a green signal, Infrastructural fast tracking system has to be made robust and the government borrowing finances has to be restructured for giving this economy the required push and to pause the free fall of Indian National Rupee.

Similarly in China the manufacturing growth is plummeting, the PMI data is weak and decline in the global demand is a cause of worry. On the west, Euro Zone survived with the Greece’s elections but the stability of the union is still in doubt. The monetary union don not stand on the fundamentally strong fiscal pillars which is making the survival difficult for the group of countries. And bailouts are not the solutions to the complex issues.

Federal Bank of USA has also extended the Operation Twist (after 2 QEs) till this calendar year end but economy is still growing at a worrisome rate.

All the above mentioned facts highlight the urgency of fiscal consolidation. The government around the world has to take gutsy steps, bring in reforms and infuse positivity in the market to affirm the investors about their safe investments. Even if there are plethoras of more Easings or OMOs planned, the economy won’t stand on its own until the sustainability is assured through prominent reforms. And that is a must now for survival of the global as well as the domestic markets.

India the Next Greece?

An Italian bank's boss recounts a joke of two hikers picnicking when a bear appears. When one laces up his boots to run, his friend scoffs that he can’t outrun a bear. The shod hiker retorts that it is not the bear he needs to outrun, merely his fellow hiker. “We’re sitting at the picnic with our boots still on,” says the bank boss.

As the ‘Grexit’ scenario looks inevitable, banks and investors have already started taking precautions by pulling out their money from the fragile markets like Portugal, Ireland, Italy, Greece and Spain. Spain and Italy have alone lost foreign bank deposits of about €45 billion and €100 billion respectively from their peaks. On the other hand sales of government bonds by foreigners and capital flight is probably equal to about 10% of GDP in those countries. So the sound of credit crunching can be heard in these countries loud and clear.

Though there are many prominent differences between India and Europe in their economic structures but still there are two apparent similarities with Europe which brings to fore the riskiness of the present volatile economic situation. First is the India’s debt to GDP ratio which has already been unacceptably high, declared by the international financial standards and the soaring Fiscal deficit coupled with the bloated Current Account deficit. And the second similarity lies with the large presence of international investors and creditors which not only increases the volatility but also causes economic instability because the sudden influx and exodus of these investors shocks the economic momentum and leaves it gasping.

Undoubtedly there are external factors which have impacted the domestic economy to a large extent but it should also not be forgotten that the government failed to protect the economy from these shocks through its inaction. Even when confronted with the low growth, the government tends to adopts austerity measures that trap the country in a recession. And this is what happened in Europe and so it can also become a reality for India.

Paul Krugman in his latest article in a leading newspaper describes this situation by saying that the economy is a unit where one’s spending becomes the other’s income and vice-versa. So what happens if everyone simultaneously slashes spending in an attempt to pay down debt? The answer is that everyone’s income falls and it worsens the debt problem.

The way out of this vicious cycle as clarified by economists is to expand the spending and find other alternative way to address inflation or balance of payments difficulties which can only be possible if the government takes on the challenges head on at least now in these dire situations.

Clogged Connectivity

The Telecom Regulatory Authority of India (TRAI) and Department of telecommunication (DoT) it seems are in race to fill the exchequer by quoting higher reserve prices to auction spectrum than each other. Trai benchmarked 2G spectrum rates by keeping 3G auction price as their base price and came up with a figure of INR 3,622 crore per megahertz (MHz) for pan India license.

The figure discovered by the authorities would have been justified if the players involved in 3G spectrum auction would have been profitable after the purchase of spectrum, rather the players are finding it difficult to recover the cost through the operations as the 3G is still expensive for a middle men to use it for daily purpose and on the other hand taking 3G prices as the benchmark is also not justified because the scarcity of spectrum soared up the prices during auction. So to use the same standards or even higher prices for the ordinary 2G voice bandwidth would be a mistake, resulting in many companies dropping out of the auction and the rest would hike the tariffs which would definitely choke the development and spread of wireless voice services in the country.

Government has an aim to connect the entire nation through affordable connectivity but if the proposed auction turns to reality then affordability would be an elusive dream. It is reported by leading operators that with proposed auction plans the prices would be up by almost 30 paise to 1 rupee per minute and that is a huge jump. In the last half a decade or so, this telecom sector was considered as a rising star for the country, contributing a significant pie in the GDP growth but if the bandwidth is auctioned at exorbitant reserve prices then the gain will be lost.

Comparing the Trai’s suggested rates with similar auction elsewhere is a bit surprising. In 2011,Germany, Sweden and France auctioned spectrum in the 800MHz band for 2G voice communication. These prices were $0.95 per person per MHz in Germany, $0.54 in Sweden and $0.90 in France. And in similar terms Trai’s proposed charges would be eight times that of Germany, 22 times of Sweden and more than 19 times the French charges. These are highly overpriced.

Now, DoT wants to set these charges 17% higher at around INR 4,245 crore per MHz for a pan India license. That’s gargantuan in nature and should not be encouraged to do so. Rather the government should auction the spectrum at a base price derived from 2001 rates, indexed to inflation and it will attract more participants which would lead to the right price discovery too. Because doing so would also keep the Telecom Industry alive and that is really imperative to remain connected.

GAAR – Ambiguity Persists

 Introduction of the a contentious  new tax proposal by the government, called the General Anti-Avoidance Rule, has dented the market sentiments and is likely to hurt foreign investments too.

The General Anti-Avoidance Rule was introduced with the objective to "counter aggressive tax avoidance schemes."  It empowers officials to deny the tax benefits on transactions or arrangements which do not have any commercial substance or consideration other than achieving tax benefit. It could also be used by the government to target participatory notes (P-Notes).  GAAR would also empower the tax authorities to overcome the Double Taxation Avoidance Agreement (DTAA) and deny the benefits of Tax Avoidance to the FIIs which route their investment through Mauritius which is a Tax Haven.

On the other hand, the Indian Government has reiterated many times that India is not a Tax Haven and would take cautious steps in consolidating this stance. The government has also stated that the double taxation avoidance treaty has been exploited by foreign investors, especially in the capital market, to avoid capital gains taxes in India but with GAAR they are bound to prove the substance of their business in Mauritius.

It is not only a domestic issue rather tax avoidance is of international concern now and several countries have either already codified GAAR in their tax statutes or are in the process of doing so.  GAAR has been a part of the tax code of Canada since 1988, Australia since 1981, South Africa from 2006 and China from 2008. Australia and China also have SAAR (Specific Anti Avoidance Rule) in place to check abuse of tax treaties and transfer pricing.

But the lack of clear indication of how and on whom the GAAR would be imposed, this is what is spreading an alarming negative sentiment across the economy. Then the concern of treaty override needs to be handled carefully otherwise it would lead to violation of international convention. Analysts also feel that the timing of introduction of GAAR was not appropriate when the image of our country was reeling with negativity like policy paralysis, CAD and Fiscal Deficit.

So let’s wait and watch how the Finance Ministry would act on this ambiguous proposal.

RBI’s Closed-Eye Bonanza?

In RBI’s annual monetary policy review meeting, a surprise was unfolded by the central bank:

·         With Repo Rate cut by 50 basis points (bps) after a long time.

·         Reverse Repo and Marginal Standing Facility was placed above and below by 100 bps.

·         MSP now stands at 2 percent of their outstanding Net Demand and Time Liabilities (NDTL) from 1 percent before.

These major changes in the monetary policy really boosts RBI’s expected GDP growth rate of 7.3% in 2012-13 but the point to be contemplated upon is: Will this estimation turn out to be a reality? Many experts believe that monetary easing alone would not be sufficient to boost the growth projection. And it is absolutely correct because until our Fiscal deficit and Current Account deficit is not tamed the projected momentum is an elusive dream. This clearly points out the policy paralysis in which our system is currently entangled. Even in the recent budget there has not been an impressive reform to boost our economic condition.

On the other hand thought with persistent rate hikes by the RBI it has clearly succeeded in bringing the inflation under control but still there are Inflationary pressures, especially food inflation, have regained momentum and the upside risks have risen. In coming months, consumer goods and services inflation would also be adversely impacted due to indirect tax increases. Inflation declined temporarily after November 2011, but has remained stubborn at 6.9 per cent in the fourth quarter of 2011-12. Finally, coal and electricity prices are already being revised upwards and the process is likely to continue throughout the year. The wage-price spiral in India has strengthened since last year, because wages in the rural economy now rise in line with inflation, with inflation-linked wages under Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS) setting the floor. All these inflationary alarming bells can get louder if ignored.

External factors like demand from the Rest of the world has also been bearish, rising fuel prices and the world economic volatility has also applied brakes on the exports growth of our country and putting appreciative pressure on the rupee. Coupled with all these factors the slowdown in the investment has also been attributed for this tepid growth rate. Hence, for growth to revive, the investment climate, supported by appropriate policy reforms, will have to improve.

So it can be concluded that though RBI did its part by easing up of the monetary policy but still it cannot alone provide the required impetus to the economic momentum, it definitely needs government’s support to push the reforms ahead for prosperity and economic stability.

Retrospective Amendment: Justified or Vindictive?

In 1965 while delivering a public lecture on The Indian Tax System, late Mr Nani Palkhivala, one of the most revered tax lawyer of India highlighted the uncertainty of the tax laws in the country and cited its unpredictable nature as one of the pernicious characteristic. Now in 2012, British chancellor of the exchequer George Osborne called for “greater predictability) in the Indian tax policies. Connecting the dots would help us to understand the issue now.

In Budget 2012-13, Finance Minister Pranab Mukherjee has proposed amending the Income Tax Act retrospectively from 1962 to bring under net overseas deals involving domestic assets. This would have a bearing on Vodafone which won the legal dispute in Supreme Court over Rs 11,000-crore tax claim raised on its USD 11-billion deal with Hutchison Essar in 2007. Now, the retroactive law threatens to upturn the court verdict.

Will this verdict be overthrown by the Government’s amendment in the law or will the Apex Court’s decision will be given supremacy? The question is not only confined to the inland domestic tax situation but with this amendment will the Foreign Investor’s investment in the country would also be impacted or will the sentiments get dented? This question is also extremely important to be thought upon.

Though the Government official justifies the step taken by the Finance Minister and also confirms that the amendment won’t affect the FDI inflows in the country, which is already under a great stress from the other parties’ objection. They also have a view that amendments in The Income Tax Law is normal process and happens every year, in 2007-08 budget, there were eight amendments in tax laws, five amendments in 2008-09, four in 2009-10 and eleven in 2010-11.

But on the other side there are views from the industry that such amendments would hamper the sentiments of the large business houses and their investment in the country. Mr Ashok Malik, a political commentator feels that “post facto laws are increasingly seen as immoral and vindictive. Today, with international capital flows intensifying, the rules of the game cannot be changed mid match”. If the amendment would have been for the future deals of the similar fashion then it would have been a completely different issue. But the present amendment can even rope in deals like Kraft Foods’ acquisition of Cadbury India, SABMiller’s purchase of Fosters etc, so that is why the present issue is getting more and more debatable.

Though the government would proceed with the present amendment made in the law but it should definitely take into consideration the present situation of our country. Today our nation requires a boost of reforms and financial stimulus in the key areas of the economy to continue to attract the foreign investors on the land which provides equal opportunities for everyone who pitches in for business and to move on the trajectory of 8% GDP growth rate. And through these changes in the law I somehow believe that the government on its own is creating a self defeating economic agenda which can negatively impact the long term prospects of the nation.

Unabated Euro-Zone Crisis

There is negativity surrounding the euro zone nowadays; huge sovereign debt, austerity measures on the roll, further taxes for the public and lowering of credit ratings of countries like Britain, Austria, France, Italy, Malta, Portugal, Slovakia and Slovenia by Moody, Standard & Poor and Fitch clearly highlights the damaging financial scenario for the block of nations. Presently only few countries like Germany, Norway, Sweden and Denmark are holding strong and keeping away from the negative ratings, rest all the other countries left are under a close watch by these agencies.

The crisis has taken toll on countries like Greece and Portugal in such an extent that now it is difficult to find solutions for their debt-empowered economy. There are strings of bailout packages which are being utilized in such a way that it would reduce their Debt-To-GDP ratio up to some extent to kick start their economies. But the things are not working; the austerity measures have almost crippled the public spending which resulted in an extremely slow paced growth for the union. These countries have to deal with high fiscal deficits and so dropping the growth momentum too.

Huge debt on these countries have raised obligations towards more interest payment and so the government spends less for the welfare of people, levy more taxes by expanding the tax payable population base and borrow more, which has great impact on the domestic companies. The crisis may even lead to fall in exports to the European countries crippling India’s total exports. 75% of these exports are from manufacturing sector which would impact the domestic industrial production too. As slowdown will affect exports, it can lead to an increase in the already high India’s current account deficit. Further, the stock markets can witness a slowdown in funds from this region as the Foreign Institutional Investors and ECB would require funds to meet their own capital requirements and obligations back home.

So, all these factors clearly highlight the interdependency of one country over another and signifies the crippling effect too. So if the Euro Zone crisis is not solved early it would have a chain reaction which would not only engulf the European countries but also could have serious impact on the developing countries like India.

Though still a positive for India is that it is trying its best of becoming a self sufficient country in all the aspects, barring Oil & Gas, and is not primarily dependent on exports. Secondly, India has diversified its export portfolio in different geographical regions too which would definitely act as a cushion for the country in mitigating the adverse impacts borne out of this crisis.