|Forget Mauritius, for now|
|Saturday, 05 May 2012 00:00|
Let’s focus on ensuring there’s no BoP shock
To be fair to minister of state for finance SS Palanimanickam, his statement in Parliament that India was considering a review of the Double Taxation Avoidance Agreement with Mauritius was a mere reiteration of a well-known official position. But given the uncertain times we live in, this spooked the markets enough for them to fall 200 points. If the Mauritius agreement costs India $600mn in taxes each year, to quote the figure most often cited, it is difficult to argue the treaty shouldn’t be revoked, more so since there is little evidence tax breaks are the fundamental drivers of investment. But as pointed out by Chicago university professor and the Prime Minister’s honorary advisor Raghuram Rajan some weeks ago, while he was in favour of re-negotiating the Mauritius and Singapore treaties, the right time for this couldn’t be when the current account deficit was over 4% of GDP. Given the fragile nature of the twin deficits which, in many ways, are looking as ominous as they were in 1991 before India had to ship gold to the IMF, the last thing India needs is to upset foreign investors.
How fragile things are has been best brought out by a recent report by Morgan Stanley which talks of the risks of a balance of payments shock in India being high. And for those who argue the current account deficit is essentially just due to gold imports being high—so, by this logic, the deficit is not a structural one and is easily fixed by, say, raising import duties on gold—Morgan Stanley economists argue this were gold imports to fall to a more normal level, the current account deficit would still be a high 3% of GDP. More important, they argue, gold imports are a consequence of the inflation problem and won’t go away till there is more certainty in people’s minds. If the deficit isn’t bad enough, a greater problem is the way it is financed—as compared to 44% in the 2001-10 period, the share of debt-creating inflows was 65% in FY12.
The larger fear, of course, is how the current account and fiscal deficits are feeding on one another through the oil deficit. A high current account deficit leads to a fall in the value of the rupee and each 10% fall in the rupee’s value leads to the subsidy burden rising by 0.17% of GDP—RBI’s moves yesterday to help slow the rupee’s slide may help, but market players believe the impact will be limited. A higher subsidy burden, and this includes the subsidies borne by the oil PSUs, is what has led to the sharp fall in overall savings and, hence, lower GDP growth. In such a situation, any further slowing in forex flows can trigger a serious crisis. It is this, not a $600mn loss, that needs to guide India’s tax policy.