Foreign investors ask for too much (and we oblige most of the times)..

Prof. Ashima Goyal of IGIDR has a timely piece on FII-MAT issue:

The fall in Indian equity prices should not be interpreted as a fallout of the tax administration’s decision to impose minimum alternate taxation (MAT) on foreign portfolio investors. Much of the foreign portfolio outflows are influenced by global factors such as fragility in bond markets and a rebalancing towards Chinese equity, which has risen sharply due to Chinese monetary stimulus.

That said, the MAT issue has had a strong effect on perceptions. This is despite the policy message aiming to make the system more predictable and user friendly, and the announcement that MAT would henceforth not apply to foreign portfolio investors (FPIs). Greater clarity should actually lead to more inflows. Savvy investors should be taking advantage of the correction.

A valid grievance is the delayed imposition of the tax, after FPIs had settled their accounts. It has reinforced the reputation of an administration out to squeeze as much revenue as possible.  But the quasi-judicial bodies that took the decision to levy MAT were created partly to make the tax system free of political interference.

There are legal remedies, since rulings can be contested in the upper courts. Even so, the message of a friendly tax administration needs to be clearly understood at all levels of the tax hierarchy, with restructuring to reduce multiple centres of power and discretion. Junior officers have too much power to make arbitrary demands as part of chasing tax targets.

India needs to develop its capital markets, and the country has opened up to foreign investors partly for that purpose. It has to honour its contract with them, but tax concessions given at a development stage cannot last for ever.

Harsh words like tax terrorism etc were used in this case.

Keeping this tax issue aside, it is alarmingly getting clearer how opening up to foreign investors leads to erosion of sovereignty. The govt has been helpless ever since the issue has broken out and was required to give number of clarifications. Compare this to several hapless citizens who are made to to several rounds of tax authorities for all kinds of taxes. They have no voice whatsoever. But FII’s collect together and threaten markets leading to genuflection of the govt.

Rodrik’s trilemma is kicking big time.

Sometimes simple and bold ideas help us see more clearly a complex reality that requires nuanced approaches.  I have an “impossibility theorem” for the global economy that is like that. It says that democracy, national sovereignty and global economic integration are mutually incompatible: we can combine any two of the three, but never have all three simultaneously and in full.

Here is what the theorem looks like in a picture:



So what do we do?





As govt has clearly indicated, economic integration will only rise with full capital account convertibility (and what not) expected in few years. This means we either do away with nation state or democracy. Democracy is pretty deep rooted here and likely to remain localised. It is nation state and sovereignty which stands to be compromised as it responds only to the needs of the global economy. This despite the fact that how badly global economy actors have behaved over the recent years.


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