India at Crossroads

As promised, I am writing about fundamentals of our country and I hope you will enjoy this attempt as much as my technical writing so far.

The question probably everyone is asking is what went wrong suddenly? We were cruising pretty well. In spite of slow down and Europe turmoil we were doing pretty decently for ourselves. Inflation was coming down, RBI was to start lowering policy rates, growth were to pick up and all that. What happened?

It is difficult to pin point as to what exactly was the tipping point of all this but if I have to choose one, I will choose our General Budget as the proverbial nail in the coffin. Government has been fiddling with policies and overlooking long term impact of postponing reforms (probably in order to make sure the reign of Prince in Waiting, Rahul Gandhi) since long. However couple of announcements in the budget were too much.

First was Retrospective changes in the Taxation laws. It really spooked the Foreign Investors.

Imagine a case where you have bought a house or car and suddenly you are asked by Government to pay substantial tax on that after 5 years. You go to court (Supreme Court mind you) and get a decision in your favor. Story should end here... but not in India. Government, rather than being a mature party... behaves like a brat and changes the rules of taxation and also makes them effective on past transactions too. With this case in mind, would someone buy a house or car in India?

Now I am not saying that Vodafone is not guilty here. Their transaction was totally built in such a way only to avoid tax in India. They were also served a letter saying that they will need to pay tax on the said transaction. So they are not totally innocent and Hutch was supposed to deduct their tax at source. That did not happen but more than that... what I think, is that they probably pissed off someone in Government in a wrong way. Result: Government wants to collect tax from them at a cost which could be multiple of that amount for the rest of the economy.

It is a very difficult call whether to let the Vodafone go scot-free in this case ot not but this whole thing could have been done in such a way as not to scare FIIs so badly. When your imports are much larger than your exports and you depend on all the FII/NRI money to balance your accounts, you do not play ball with them without rules. With no FII money to help Government limit the deficit, see how quickly we have come to 56 INR/$.

Second bad provision in budget was regarding VC/ Angel funding for start-ups. To cut the long story short, it was probably a good initiative with no thinking about the complexities involved in its implementation. It gave discretionary powers to IT officers with onus of proving innocence on assesses. It basically meant you are guilty (of tax evasion) unless proven innocent. This was a punishment for genuine start-ups who need these funds for the fault of few who misuse these arrangement to evade some tax. This provision created doubts for VC funds and slowed their economic activity.

Now impact of such provisions is not counted only in terms of the amount of money which froze, it also affects sentiments. And in today's world, it matters a lot. The announcements in budget created a impression about how unwelcome and unreliable we are to investors. People in today's world, marred by US housing bubble, scarred by Europe... may settle for less returns but they will prefer security of their capital and clarity about their liabilities. They will want clear policies and faster decisions and simply hate uncertainties. Can't blame them.

Another reason for fall in INR is the increasing strength in US $. In last three months alone the DXY has reached above 82 from a level of 78. This is also hastening the decline of the Rupee.

Now the real question is whether RBI should intervene and stop the slide of Rupee further? My call; NO. RBI should let the Rupee find its own level dictated by Market. It may not be a bad thing for Economy. On the contrary, it may be best thing to happen to economy in a long time.

More on that in next post.

I hope you will like this return post and keep encouraging me like earlier to write more. Looking forward to your comments.