India's inclusion in global bond indices faces taxation hurdle

India expects an additional foreign money inflow of about $20 billion annually into the government debt market once the country joins the indices
India’s entry into the global bond indices has got postponed because of tax changes sought by their managers. They have also demanded that India list its sovereign debt papers on leading international central securities depositories like Clearstream. This means that taxes on these papers, such as withholding tax, will need to be frozen. The government will have to give in writing that taxes will not be changed to the disadvantage of investors.

Over the past two years, both the finance ministry and the Reserve Bank of India (RBI) have been in discussion with the managers of at least three global benchmark indices, including the Bloomberg Barclays Global Aggregate Index and the JP Morgan GBI EM Index. India expects an additional foreign money inflow of about $20 billion annually into the government debt market once the country joins the indices. It will also help bring in large passive investments from overseas.

“The tax issue in particular is a challenge since we have to cede a certain amount of our sovereign authority,” said an official aware of the development.

To make the compliance regime, India has offered to come on a par with most OECD (Organisation for Economic Co-operation and Development) countries whose papers are part of these indices. New Delhi may even need to sign a new double taxation avoidance agreement (DTAA).

India has extensively revised its DTAA template in the past few years  to give the government a greater say, and this demand is like going back on that. The finance ministry is examining the alternatives to join the international central securities depository networks, but without having to cede tax sovereignty.  

The demands have come when India is fighting adverse tax awards by international arbitration tribunals in the cases like Cairn Energy and Vodafone. While the content of those awards has nothing in common with the fresh demands made by the fund managers, government officials accept that the perceived concern about India’s tax rules could have triggered the move.

Government officials described the new requirements as “unfair”. The funds had asked India to offer security that global investors, mostly pension funds which populate these indices, could sell their investments whenever they wished.

The finance ministry and the RBI had been able to allay those concerns. They made all the necessary changes to be considered for inclusion in the indices, the official quoted above said. The RBI has launched a fully accessible route (FAR) option for unrestricted investment in government papers. Under the FAR option, there are no restrictions for investments in the designated government papers. The RBI has designated two stocks maturing in 2024, two in 2029, and one security maturing in 2049 with a potential investment of close to $58 billion.

The fresh demands are embarrassing since China has already established itself in the Clearstream settlement system since 2017. India is also upset as the demand for tax certainty has not been insisted upon for other countries that are part of the international central security depository networks. Being part of these depositories based on rules framed by the European Commission in 2012 puts obligation of dematerialisation for the traded securities, a harmonised settlement period for their transactions, and a clutch of other rules to ensure settlement discipline measures. India had floated plans for a sovereign bond in the Budget 2019 but was replaced next year with plans to join the global bond indices.

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