MUMBAI (Reuters Breakingviews) - When it comes to India, fund managers are sitting on their hands. Foreign flows into the country's equity market have trickled to a halt this month. Ambiguity over tax rules is a major reason why investors are holding back. India's fragile economy can't risk an exodus. But it still has time for a re-think.
Overseas investors have only invested $172 million in Indian equities so far this month. That compares with an average of around $3 billion a month which was invested in the first quarter of this calendar year, according to the Securities and Exchange Board of India. The benchmark Sensex is down around 8 percent from its pre-budget high on February 21. The rupee hit a three-month low on April 24.
Worries about India's economic growth and the global selloff triggered by renewed jitters over the euro zone may be partly to blame. But fund managers also point to uncertainty over changes to Indian taxation. Proposed rules prompted the $1.5 billion Macquarie Asian Alpha Fund to exit short positions in Indian single stock futures, Reuters reported on April 23.
The prospect of a retrospective charge on foreign investments, aimed mainly at Vodafone's purchase of Hutchinson Whampoa's Indian assets, has affected sentiment. But there is also ambiguity over the country's proposed 15 percent tax on short-term capital gains. In spite of some reassuring platitudes from the finance minister during his visit to the United States last week, nothing has actually changed.
New Delhi can't afford to keep investors guessing. India's trade deficit hit a record high of $185 billion for the most recent fiscal year, up from $104 billion in the previous 12 months. Even if net capital inflows from foreign investors and remittances by foreign workers remain steady at around $120 billion, the country faces a $60 billion shortfall. But if foreign direct investment and portfolio investment dry up, the gap could double to $120 billion.
Fortunately, there is an easy enough remedy. The finance bill has yet to be made law. If India removed all efforts to retrospectively change the tax code and made crystal clear how the anti-avoidance rules will impact institutional investors, it could help to lift the uncertainty.
- Overseas investors have invested just $172 million in the Indian equity market so far this month. That compares with $1.7 billion in March, $5.1 billion in February and $2 billion in January, according to data taken from the Securities and Exchange Board of India's website on April 24.
- Foreign institutional investors currently hold around 17 percent of the total market for Indian equities, equivalent to around $200 billion.
- The $1.5 billion Macquarie Asian Alpha Fund has exited its short positions in Indian single stock futures in response to a controversial set of proposed tax rules that could lower investment returns, Reuters reported on April 23.
- Investors fear that New Delhi will use changes to tax low that could trap Vodafone to snare offshore institutions as well. At the heart of their concerns are two provisions. The first gives India the power to retroactively tax the indirect transfer of assets, which was widely seen as targeting Vodafone's $11 billion purchase of Hutchison Whampoa's Indian assets.
- The second targets tax evaders via the General Anti-Avoidance Rule (GAAR) and may expose investors to a 15 percent short term capital gains tax.
(The author is a Reuters Breakingviews columnist. The opinions expressed are his own)
Editing by Peter Thal Larsen and David Evans