Finance minister Arun Jaitley has done well to finally announce a high-level panel under Law Commission chief Justice AP Shah to examine the FII MAT issue, and to promise the government will take a quick decision on its recommendations—quite a change from the earlier position that FIIs could not expect preferential treatment, but they were welcome to approach the courts, something that could have taken years. Given that FII investments in equity alone are $345 billion, the last thing the government would want is for FIIs to carry on exiting the markets—over the last 10 sessions, $2.15 billion was withdrawn by FIIs and that caused both the Sensex as well as the rupee to collapse. It is probably to avoid such a situation that, though the Castleton ruling by the Advance Authority for Ruling (AAR) that Jaitley spoke of was given in 2012, no tax notices were sent out under previous finance ministers. In examining the matter, the Shah panel will essentially look at whether MAT can be levied on firms that do not have a permanent establishment in India—while Jaitley cited one ruling in favour of the taxman, there have been several against the taxman that he did not cite.
Whether a favourable resolution of the MAT issue will halt the FII exodus, of course, remains to be seen since there are several other factors at play. With the Sensex running up 12.37% since Modi won the elections, India’s markets are one of the most expensive in the world, trading at 16.7 times forward P/Es compared to a much lower 12.4 for China and 10.1 for Korea. While it looked as if there would be a sea-change in the economic environment under Modi, FIIs went overweight on India and, according to a Goldman Sachs report, emerging market funds are 475 bps overweight on India vis-à-vis the MSCO weight of 7.5%—Asia ex-Japan funds are 595 bps overweight. In contrast, emerging market funds are 757 bps underweight on
Korea and 230 on Taiwan where valuations are far more attractive. With the continued string of bad results, earnings estimates are being downgraded regularly—from R1,884.75 on November 1, 2014, the FY16 Sensex EPS is currently R1,768. In such a situation, other markets are looking more attractive. Which is why most expect the FII outflows to carry on—how long the re-balancing will take, and how deep it will go, of course, is the question.
In such a situation, though ICICI chairman KV Kamath has rushed to Modi’s defence—in an interview in The Economic Times—after Arun Shourie’s searing critique, it is important the government gets some clear reforms going. More so since
Kamath’s recipe of a 200 bps rate cut to get demand going isn’t going to happen over the next year or two. Indeed, while trying to make a distinction between poor bottomlines of corporates and the government’s performance, and blaming the former for the current mood, Kamath himself talks of the importance of the Land Bill getting passed and of the government stepping in to play a key role in infrastructure creation—with the Opposition acting the way it is, and the Budget in the shape it is, neither look very possible right now. In such a situation, a high-handed tax administration is probably the last thing India needs.