Saturday July 28, 2012
Flip-flopping the future away
Governance Matters by SHIREEN MUHIUDEEN
WHENEVER governments flip-flop on policies, they do not seem to see that by doing so will have long-lasting impact on investors. Anyone who is thinking of investing in a country would first want to be assured that its policies are stable and its government's past actions are consistent.
We do appreciate that sometimes, a government may have to ditch entrenched policies to welcome new sources of revenue, but even so, its policy-makers need to think very long and hard before embarking on radical changes because such changes affect all stakeholders for a very long time.
For example, what if you are suddenly faced with a new tax ruling on your investments that go as far back as half a century? Would any government contemplate that far-reaching a change? Unfortunately, one such government has; India has just proposed a retrospective amendment to its Income Tax Act in its recent national budget. If its parliament passes this proposal, India's authorities will be able to crank open tax cases from as far back as 1962. Can you even begin to imagine the number of companies that will be affected by this ruling?
This tax proposal comes after a ruling in January by India's Supreme Court that British company Vodafone Group plc will not have to pay US$2.2bil in tax on its offshore purchase of the Indian business of Hutchison Whampoa Ltd in 2007. If the Indian government's bid to amend its tax law goes through, a deal such as that of Vodafone and Hutchison would be under India's tax net.
Concerns that foreign companies will be affected as such by India's income tax laws have prompted Vodafone's Dutch subsidiary Vodafone International Holdings BV to serve a notice of dispute on the government of India. It claims that the proposed tax law violates international legal protection which India granted Vodafone and other global investors. However, Vodafone prefers to solve this dispute amicably, and so has done a regulatory filing to the London Stock Exchange to ask that the Indian government either abandon or amend suitably the retrospective aspects of the proposed tax law.
In doing so, Vodafone says, “If the Indian government is not willing to do so, Vodafone will take whatever steps necessary to protect its shareholders' interests, including commencing arbitration proceedings under the Bilateral Investment Treaty (BIT) against the Indian government.”
The company says that under the BIT, among other things, India is obliged to accord fair and equitable treatment to its investors, provide them with full protection and security, refrain from dashing the legitimate expectations of investors about their investments and neither deny them justice or breach India's previously provided assurances or take steps to expropriate indirectly these investments.
Vodafone adds that India's retrospective tax proposal has raised widespread concerns among investors internationally to such an extent that business and industry bodies representing more than 250,000 companies in the United States, Europe and Asia have criticised the country's proposed tax laws.
Such criticism has, perhaps, prompted India to assuage investors' ire by backtracking a bit on its proposal as of two weeks ago, its government said its clampdown on tax avoiders would neither apply retrospectively or catch those below a certain monetary threshold. The current draft guidelines, released by India's finance ministry, would also exempt foreign investors from the proposed law if they refrain from routing money to India via tax shelters.
The draft also suggests that any tax changes will not target foreign investors who hold Indian stocks through so-called participatory notes. The proposed guidelines also recommended a monetary threshold for applying the anti-avoidance law to “avoid indiscriminate application” but, alas, did not specify a level.
As a result, overseas funds were net sellers of Indian stocks in April and May on concerns that the planned General Anti-Avoidance Rule would apply to their holdings.
These draft guidelines are currently up for discussion and feedback, and so have not yet got the government's final nod. While the guidelines are clearly a move towards encouraging more foreign investment, one has to wonder how India's policy-makers can think such backtracking is sufficient to build confidence in global investors again.
The bigger picture in all of this is that India's government is trying to inspire confidence in its economy again after its growth slowed, and the proposed tax changes dampened global investors' sentiment considerably. India's gross domestic product (GDP) growth slowed to 5.3% in the first quarter, the slowest since 2003.
The slowdown has sapped tax revenues even as subsidies spur spending, leaving the nation with record borrowing needs to plug the widest budget deficit among the biggest emerging markets. The rating agencies including Fitch and Standard & Poor's have said “they may strip India of its investment-grade credit rating, citing risks ranging from the fiscal gap to the current-account deficit.”
India's current account deficit swelled to a record US$21.7bil in the first three months ended March 2012. For the 12 months ended March, the total current account deficit stood at US$78.2bil or 4.2% of GDP which is also a record deficit.
All that led to a plunge in the rupee which, of course, has far-reaching implications to the shores of South-East Asia's commodities.
Global finance leaders have been raising their concerns. US Treasury Secretary Timothy Geithner, for one, was recently quoted as saying that Americans had discussed India's proposed tax changes and US lobby groups complained that the changes would lead to “retroactive levies for periods of as much as 50 years and deter foreign investment” in India.
His British counterpart George Osborne has also said that the proposals “could damage India's investment climate”.
To subdue such concerns, Indian Prime Minister Manmohan Singh said two weeks ago that India needed to “reverse the climate of pessimism” and that his government's immediate priority was to manage the balance of payments and boost capital inflows into India.
The issue is not just about India though; it is a cautionary tale for all policy-makers that they have to consider the pros and cons of their proposals before deciding whether it is worth their country's while to flip-flop. The investing community will punish, and keep punishing, those countries that appear not to play fair.
>Shireen Muhiudeen is managing director of Corston-Smith Asset Management in Malaysia, a fund management company that makes investment decisions based on corporate governance.