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.

The Fear of Reliance on DEBT !!!!

The Reserve Bank of India’s third quarter 2011-12 review of Macroeconomic and Monetary Developments released on January 23, 2012 assessed that risk aversion in the global financial markets has slacked the pace of capital flows to India and if the pace of FDI inflows does not pick up and FII equity inflows follow their decelerating trend then the CAD (Current Account Deficit) may have to be financed through debt flows in the coming quarters.

As per one of the report by RBI, during calendar year 2011 as a whole, foreign debt inflows amounted to $8.65 billion, out of which almost half of it came in December. And in the same calendar year it is said to have recorded a net outflow of equity investment of almost $357 million. On one side there is a recent revival of FII inflows largely in the debt instrument and on the other there has been a collapse of foreign portfolio investment flows, leading to an overall fall in the external investment in equity. But with burgeoning CAD the conclusion arrived that India has to increase its reliance on debt creating flows to finance its deficit.

Measures such as paving way for Qualified Foreign Investors (QFI) to invest directly in India’s equity market is an explanation by the UPA government to establish the fact that it is countering the formed view of “policy paralysis” and boosting again the positivity in the market.  But they are also driven by the need to reverse the slowdown in inflows of foreign portfolio investment. The decline in FII inflows has been attributed to the development abroad, which required FII to book their profits in India and repatriate their funds to meet commitments or cover losses at home.

One danger is that though the government is trying with different measures to infuse positivity in the market by allowing direct access to equity markets but still it becomes difficult or rather impossible for Indian regulators to fully rein in these global players and impose conditions on their financing, trading and accounting practices, controlling unbridled speculation required by them to be regulated at the point of origin. And, if such investors do come in the Indian market then it would be with the intent of reaping capital gains through short term trades.

Thus to make this measure successful it would mark a transition towards allowing a more speculative base of such players in the market but defending that aspect on the ground that it would help to reduce the dependence on debt is indeed questionable.

MFI’s New Stance of Survival

Plummeting profits, huge operational costs, accumulation of losses and many more negative sentiments are now considered as synonyms when we come across any news regarding the Micro Finance Institutions and SKS Micro Finance takes the lead in this down slope trend. But to stay afloat, microfinance promoters are now sailing into new lending areas: from cycles to phones to gold and houses. This throws up a whole new set of challenges for them as well as for regulators.

About 70 to 80% of commercial funds for MFIs come from banks and much of this is priority sector lending which are 2-3 percentage points cheaper than the normal bank loans. And certain limits of these funds are bound to be lended as microfinance, that is why as per RBI rules clearly states that if more than 15% of the loans are lended for non-microfinance portion then these sectors will become ineligible for these cheaper funds. So it becomes a challenge for the promoters to follow the rules as well as to keep churning profits which are already strained that is why now they have focused on other strategy of tweaking products and operations.

In the way the new loans are delivered, there are three differences from the way MFIs operated:

·         One, the loans are larger,

·         Two, they are being directly given to the individuals, not through groups, who bore initial responsibility of checking credit-worthiness and repayments and

·         They are for asset purchases backed by collateral.

A promoter of one of the MFI from the north clearly states his intention when he says “We will now be looking for people with monthly salaries. Not the moong phali - walas (peanut sellers)”.But this poses a grave risk for the priority sector funds being used for other purposes.

All these years, the microfinance industry promoted itself as a potent means to pull people out of poverty but now, in its bid to survive, the industry is looking beyond the poor. Is this mission drift?

Different promoters have different view: Ujjivan’s founder, Samit Ghosh thinks, “If you start focusing on middle-income households, the focus on the target customer base gets diffused” but if you listen to what Vasudevan of Equitas says “Our mission is how to improve the quality of life for clients who were not able to access the formal financial sector till now. That doesn’t change”

Now as the MFIs are looking to diversify, so the question arises are they doing so out of duress or do they actually see an opportunity to help the poor in the same old way but with different products? This is the question which can be only answered as the time passes. So let’s wait and watch.

“Need for Robust Fundamentals

“India must not obsess with how fast its economy is growing and instead pay more attention to its human development indicators which are worse than even that of Bangladesh”

                                                               -Amartya Sen (Nobel Laureate)

Day in day out, all the national newspapers, journals, magazines, web portals etc are talking about the international economic situation, its palpable effects on the Indian economy, its survival chances and the cushion factors to avoid the major international impact on the domestic markets. It’s all about growth rates, inflation figure, purchasing power figures, GDP numbers and more economic numbers. But does a country’s overall growth depends only on economic numbers? Can a country prosper only with one section of society flourishing at a greater speed than the other? And can the economy only depend upon the production rates or the inflation rates? An assertive NO is the answer to all the above questions.

To make a country move on the right path of progress there are many factors other than the economic figures that play a vital role i.e. The Human Development and the societal gains. It has been starkly mentioned by Mr. Amartya Sen that just running behind the 8-9% growth rate won’t make India’s image in the world more superior until its economic factors pushes the human development and the societal factors in the same direction.

  

We as a nation are bound to break the unenviable record of the most densely populated country of the world and we also feel proud to cherish the demographic dividend which our country would benefit from in the coming future but this can only be possible if the entire population has the basic demands of food, shelter, clothing and education within their reach. And towards this direction the incumbent government has formulated The Food Security Bill which would definitely help the poor for the basic intake of the nutrition and in order to avoid the appalling malnutrition data which shows the backwardness of our human development factor.

Though in the Human Development Index we are growing at a good pace but still there is a daunting task which needs to be addressed. The literacy rate directed towards the Millennium Goal looks elusive. The rate of unemployment is also on a rise coupled with lack of sufficient shelter and food for the 1.2 billion plus countrymen. If the government pays a little more attention towards these aspects and tries to break the reform paralysis, then the magical economic figure of 8-9% growth rate of GDP can be achieved without much effort. These underlying factors’ growth is the real reason for an economy to boom.

So be it 6.9% or 9% GDP growth rate, it would not matter much if the real underlying factors are not given enough space to grow. Let the economy stand on the robust fundamentals.