| The
Manmohan Singh government pretends to be obsessed with
fears of a collapse of foreign investor confidence and
foreign capital inflows. A recent act signalling such
fears is its retreat on the question of adoption of
GAAR (or General Anti- Avoidance Rules). GAAR seeks
to prevent abusive use of provisions in the law to 'legally'
avoid (as opposed to illegally evade) tax payment, resulting
in private gains that are not in keeping with the intent
of the law or the national interest.
The rules are logical, fair and increasingly considered
international best practice. They clarify the provisions
of the law and detail the norms that should govern their
application. Many countries, including developed ones
like Canada, are already implementing their version
of GAAR. Recognising the importance of anti-tax avoidance
rules, the Direct Tax Code (aimed at rationalising and
simplifying the tax system) and the Budget for 2012-13
sought to implement GAAR in India. The move was creditable,
even if there could be debate on the adequacy of specific
provisions.
Surprisingly, an adverse response from domestic and
foreign corporations, exaggerated by the media and self-appointed
''experts'', has given cause to an influential section
of the government led by the Prime Minister (during
his short term as Finance Minister and after) to demand
deferment or even the dropping of its implementation.
The current deferment is till 2013, but if the use of
the rent-an-expert-committee practice is any indication,
the proposal would be deferred, based on the recommendations
of the Parthasarathi Shome committee, for another three
years. After that, in all probability, it would not
be implemented at all. Never has a committee set up
to stall implementation of an announced policy arrived
at its conclusions in such a short period of time.
In stonewalling GAAR on the grounds of restoring investor
confidence, the Prime Minister and a section of his
cabinet are violating the transparency they claim to
be committed to as ''reformers''. They are doing so
even at the cost of reversing the decision of the earlier
Finance Minister, Pranab Mukherjee, who stoutly defended
not just the adoption of GAAR but also the decision
to retrospectively amend the law to make clear the government's
intent on and penalise the avoidance of capital gains
taxes as it alleges happened in the case of the Vodafone
takeover of Essar. Both these are now unlikely to be
adopted. The reason given for withdrawing from this
completely sensible policy direction is the perceived
need to appease foreign investors. In fact the principal
objective of the current government seems to be that
of winning and sustaining the whimsical 'confidence'
of foreign capital at all costs. This is the altogether
new and defining feature of economic policy in contemporary
India.
What the GAAR example illustrates is the dramatic change
in India's relationship with foreign capital since Independence.
In the 1950s, there was near unanimity that winning
a degree of autonomy vis-à-vis foreign capital
was a prerequisite for consolidating India's political
freedom. Today, many see recognition by foreign capital
as a favoured investment destination as a measure of
the country's economic success. It could be argued that
India is now a mature political democracy with no threat
to its sovereignty. So there need be no fear of foreign
capital, and its recognition can serve as an ''independent''
barometer of performance. However, there is much evidence
of the ways in which sovereignty has been affected by
the accumulated presence of foreign (especially financial)
capital in the country since liberalisation.
One reason why autonomy relative to foreign capital
was seen as crucial in the post-Independence years was
that such independence was a prerequisite for the creation
of domestic policy space. Moreover, it was argued, that
only if such space existed could the newly independent
state pursue a strategy of national development that
would better the standard of living of its people. During
the first four decades after Independence India did
manage to carve out that space with policies of protection
and regulation of the volume, destination and terms
of engagement of foreign investment in the country.
Purely financial investments were discouraged or banned,
some sectors were kept out of the purview of foreign
investors, caps on foreign equity holding were set in
others, partnership with domestic capitalists was encouraged,
and the terms for technology transfer were regulated.
In these and other ways the state mediated the relationship
between foreign and domestic capital keeping the interests
of national development in mind. The policy of ring-fencing
the domestic economy and keeping a few selected gates
open was clear.
Unfortunately, the failure to reduce the power of and
discipline domestic landlords and monopolists undermined
the ability of the system to use the resulting policy
space to its full potential. It was when that failure
combined with the push of foreign capital looking for
new avenues of expansion, that dependence on foreign
finance, especially from private sources, increased.
An unusual growth trajectory was followed during the
1980s. The government borrowed domestically to hugely
expand its current (not investment) expenditure. With
supply side bottlenecks present, especially in agriculture,
this triggered inflation. To rein in inflation and keep
growth going, the government borrowed abroad to finance
imports of goods in short supply. Foreign exchange was
also used to import of goods satisfying the demands
from the upper income groups. The result was a sharp
rise in India's external debt GDP ratio. It was that
rise combined with evidence of a growing shortfall in
foreign exchange earnings relative to expenditure (or
a rising current account deficit) which led to a loss
of creditor confidence, forced India to exhaust its
limited foreign exchange reserves and precipitated the
crisis of 1991. That policy should have cautioned the
government against increasing India's dependence of
foreign capital. Ironically, the policy of liberalisation
adopted in the wake of the crisis only increased that
dependence, with a growing role for non-debt forms of
capital especially foreign institutional investment.
With the adoption of that programme of liberalisation,
regulation and control of foreign investors has been
whittled away through policy. The surge in foreign capital
inflows that followed, particularly during the first
decade of this century, has resulted in a substantial
accumulation of foreign capital in the country, especially
footloose financial capital. And as was believed in
the immediate post-Independence years, this growing
dependence has indeed constrained domestic policy space.
Nothing illustrates this more than the fact that every
new policy initiative, whether it has anything to do
with foreign finance (such as taxes on capital market
transactions) or not (such as the food security bill)
is in the final analysis assessed in terms of the impact
it would have on foreign investor confidence. Moreover,
new policies that are controversial because of the adverse
impact they would have on the livelihoods and standards
of living of a large number of the nation's citizens
(such as the grant of right of entry to foreign investors
into multi-brand retail) are advocated on the grounds
that not doing so would adversely affect investor confidence.
Matters have now gone beyond the bounds of rationality.
Take the case of GAAR referred to earlier. Sections
of the media, which otherwise favour reform, transparency
and all things related, are justifying this retreat
by the government as a response to India's equity and
currency markets being hammered by panic-stricken investors.
The absurdity of this view needs highlighting. To start
with, if foreign investors are of the kind who hammer
markets when measures that are rational, fair and in
the national interest are planned to be implemented,
then it would be best to do without such investors.
Second, it is difficult to believe that foreign investors
would altogether stay out of a profitable market if
they are not permitted to avoid taxes. GAAR has been
on the anvil ever since it became clear that the tax
treaty with Mauritius was being misused, leading to
the routing of an overwhelming share of foreign investments
into India through that country. Moreover, GAAR has
figured in past discussions over the Direct Tax Code.
So if foreign investors find GAAR anathema, they should
have stopped coming to India quite sometime back, and
even pulled out past investments made in the country.
There has been no sign of that.
Finally, though in recent times there has been much
talk of a flight of foreign investors out of the country,
there seems to be no clear evidence of that. What has
happened, as has happened many times in the past, is
that the composition of foreign capital inflows into
the country has changed. If we consider 2011-12 as a
whole and examine the composition of capital inflows,
we find that though there was a change in the composition
of investment flows away from portfolio flows to direct
investment flows, the aggregate private investment flow
into equity remained more or less the same at $39-40
billion in both 2010-11 and 2011-12. Not much should
be made of the shift from portfolio to direct investment,
since the difference between the two is largely definitional.
If a foreign investor cumulatively acquires equity equal
to 10 per cent or more of the shareholding in the target
firm, that investment is treated as direct investment.
If not, it is put in the portfolio investment box. So,
like portfolio investors, many so-called direct investors
are also looking for capital gains rather than long
term-returns and can be as flighty. Further, with the
stock market weak and volatile, investors may have preferred
not to adopt the FII route for investment. This too
reduces portfolio investment. That the shift away from
portfolio to direct investment does not say much about
investor confidence also comes through from the increased
inflows into NRI deposits that rose from $3.2 billion
in 2010-11 to as much as $11.9 billion in 2011-12.
In sum, there is no immediate need for the government
to panic on grounds that foreign investors are panicking.
If it still does bend over backwards, as in the case
of GAAR, to please foreign investors it would be for
two longer-term reasons. First, a strategy of growth
predicated on large inflows of foreign finance, which
requires constantly appeasing investor sentiment. That
strategy is particularly vulnerable in a period when
the current account deficit is widening substantially,
as it is today. And, second, the fear that if foreign
investors lose interest in India and withdraw their
footloose, financial investments balance of payments
and currency crises cannot be prevented just because
the country has accumulated reserves based on capital
inflow.
The GAAR example is telling for another reason. Though
not devised primarily as a revenue raising measure,
there is no gainsaying the fact that it (and the related
adoption of retrospective rules on capital gains taxation)
would help the government garner much by way of taxes.
There are many measures of relevance to India's poor
majority, varying from an expanded employment guarantee
programme, provision of subsidised food through the
public distribution system, minimal social security,
education for children, health facilities and safe water
and sanitation, that require financing. Advance on every
one of these fronts has been absent or wholly inadequate,
with the government attributing failure to the lack
of resources to finance these ventures. Moreover, expenditure
on these activities in the absence of resources is seen
as contributing to a rising fiscal deficit, which too
erodes investor confidence. Thus, the need to appease
the foreign investor not only constricts policy space
but also does so in a way in which there is an almost
direct relationship between the concessions made to
the foreign investor and the benefits not accorded to
those who need them most and have been deprived of the
gains of growth for long.
In sum, pursuit of a strategy of development predicated
on ensuring large and persistent inflows of foreign
capital tends to be one that fattens the rich by depriving
the poor. This tendency towards rising inequality is
intensified because the strategy requires more than
just permitting private investors retain what they rightly
or wrongly already appropriate. It requires enlarging
the spheres from which they can draw more profit. Through
new tax concessions, transfers of various kinds and
sale of land and scarce assets to the private sector
at extremely low prices, the government has to engineer
profit inflation.
This role of the government clearly played a role in
driving the surge in capital flows that supported growth
during the last decade. While this was a period when
globally there was a sharp rise in cross-border flows
of capital, India was a favoured beneficiary because
of actions adopted by the Indian government. Just before
the FII surge began, and influenced perhaps by the sharp
fall in net FII investments in 2002-03, the then Finance
Minister declared in the Budget for 2003-04: ''In order
to give a further fillip to the capital markets, it
is now proposed to exempt all listed equities that are
acquired on or after March 1, 2003, and sold after the
lapse of a year, or more, from the incidence of capital
gains tax. Long term capital gains tax will, therefore,
not hereafter apply to such transactions. This proposal
should facilitate investment in equities.'' Long-term
capital gains tax was being levied at the concessional
rate of 10 per cent at that point of time. The surge
was no doubt facilitated by this further concession
that converted India's equity market into a tax-free
enclave.
Once on this trajectory, the policy of continuing ''liberalisation''
in which the state persistently favours private capital
is justified by arguing that foreign investor interest
is waning because of the ''slowing'' of reform. All
India needs to do, the advocates of the neoliberal strategy
argue, is announce a few ''big ticket'' reform measures,
such as opening multi-brand retail for foreign investment
or allowing sale of equity in public sector banks to
foreign investors, for investor confidence and the economy
to revive. This means the government should also not
prevent foreign firms from benefiting from ambiguity
in the law, such as happened in the case of tax avoidance
by Vodafone when it acquired equity in the Indian cell
phone industry. What is ignored here is that neither
have foreign investors runaway as yet nor have they
come only when they had these ''big ticket'' concessions.
Hence, by advancing such arguments the advocates of
reform reveal the role of the state and the parasitic
nature of capital in this regime of accumulation, which
requires persistent concessions to coax the latter into
investing for growth. The relationship between foreign
capital and India has indeed changed—only for the worse.
*
This article was published in the Frontline Volume 29,
Issue 19, September 22- October 5, 2012. |
