At one time, it was thought that “unearned” income should carry a higher rate of tax than “earned” income. Over the last few decades, however, this has changed dramatically: as Warren Buffett, one of the world’s richest individuals, once famously remarked, he pays a lower rate of tax (income is capital gains) than the marginal rate paid by his salaried secretary! But such issues apart, the question is whether the tax demands on FPIs could turn out to be the proverbial butterfly in chaos theory, or the straw that broke the camel’s back?
As it is, there are enough “Fault Lines” (the title of one of Dr Raghuram Rajan’s books) in our imbalance
of payments. Some of the more important ones include:
Thanks to the persistent deficits on current account year after year, our net international investment position has deteriorated from negative $50 bn at the end of March 2008 to negative $350 bn now, 17% of GDP, one of the world’s highest ratios -- despite “record” reserves. The outstanding portfolio investment was $210 bn at the end of December 2014.
Most funds are over-weight on India; recent corporate results have been disappointing to negative; market seems fully priced; and there often is a herd instinct amongst portfolio investors. While foreign direct investors, having come in, cannot go out quickly; portfolio investors can do so by pressing a few keys on the computer.
The real effective exchange rate index suggests overvaluation of the currency by 25%! I am aware that our Governor does not consider the REER index to be a good measure of the equilibrium value of the currency: see Abheek Barua’s column What is the right value of rupee, Mr Rajan? But empirical evidence suggesting an overvalued rupee is strong: despite a sharp fall in the price of oil, our largest single item of import, the merchandise trade deficit remains around $140 bn, and information technology services growth is decelerating. And, we would likely report a deficit on current account over 2014-15, despite a huge subsidy of $80 bn in the form of remittances, which, surely, are not our “earnings”. It is also debatable whether the oil price could flare up again partly because of the Sunni-Shia (read Saudi Arabia-Iran) tensions in West Asia.
Umpteen tax disputes with both direct and portfolio investors are hardly conducive to creating an image of India as an attractive place to invest in.
One worries whether the finance minister’s anxiety not to cross the Laxman Rekha
of fiscal deficit could lead to an “earthquake” in another segment of the economy!