India’s Finance Minister will be assessed by international investors on policy changes to increase foreign inflows, clarify tax laws and expand the country’s tax base, in his presentation of the Union Budget shortly after the latest gross domestic product (GDP) data is released today.
India's current-account deficit (CAD) has worsened since 2008 due to slowing exports and expensive oil and gold imports. It recorded a current account deficit of $22.3 billion in the third quarter of 2012, or 5.3% of GDP, the worst in a decade. That compares with less than 1% of GDP in the first half of the last decade.
“The Finance Minister has to steer the country away from the danger of being the first BRIC country to lose investment grade status via a credit downgrade,” said Bundeep Singh Rangar, Chairman of London-based advisory firm IndusView. “He has a challenging task of revving a growth engine, that sputtered under his predecessor, with the fuel of more foreign capital and wider tax collections.”
“India’s current tax base represents fewer than 35 million, or a dismal 3% of its population,” said Rangar. “That contrasts the size of its middle class estimated to be 250 million people that’s expected to reach 600 million by 2030.”
India’s CAD is being financed through stable capital flows, according to India’s Harvard-educated Finance Minister P. Chidambaram. In 2012, Foreign Institutional investments (FII) totaled $10 billion and the country attracted $27.3 billion worth of Foreign Direct investments (FDI). Both combined represent $37.3 billion, which isn’t enough to feed the growing CAD.
On the other hand, annual remittances into India that currently fuel the world’s largest remittance-corridor, surpassed $70 billion in 2012, as NRIs took advantage of a week rupee and high deposit interest rates at Indian banks.
“India’s secret weapon is its 25 million strong overseas diaspora who sent twice as much money into India in 2012 than FDI and FII combined and more than net earnings from exports of software, business, financial and communication services,” said Rangar. “$70 billion in annual remittances by Non-Resident Indians (NRIs) provides India with a distinct advantage over other BRIC economies.”
“Cutting subsidies and privatizing public sector companies will only go so far,” said Rangar. “The Budget should make it seamless for Non-Resident Indians (NRIs) to use their remittances to invest in Indian company securities, mutual funds and other investment products and foster an increase in annual remittances into India.”
“India needs to attract more inward investment and better collect tax to fund the $1 trillion requirement outlined by the Prime Minister to build the country’s infrastructure over the next five years,” said Rangar. “Better infrastructure is critical to increase India’s GDP as it will shear waste and inefficiencies in agricultural and industrial output.”
To attract foreign investments, the government should best amend its controversial tax law and not impose tax with retrospective effect on overseas deals involving local assets. India has also said it may soon finalize the rules for a proposed clampdown on tax avoidance as it considers delaying implementation of a plan that also spooked foreign investors.
India is currently aggressively pursuing tax claims against multinational firms and has targeted several companies for tax audits on transfer pricing.
“The Indian tax man’s potential treatment of low cost intellectual capital work allocated by India to multinationals, as being a higher value service and therefore, taxable at higher rates, will give reason to multinationals to seek other jurisdictions where taxation is simpler and the cost advantages are as good, if not better than India,” said Rangar. “The tax man should focus its efforts to widen the tax base and therefore, increase revenue.”
India, currently the world’s tenth-largest economy, is vying to be among the top five by 2022, according to the London-based Centre for Economics and Business Research (CEBR).