Column: MAT on FIIs – Don’t kill the golden goose

From PSU divestment to India Inc and banks raising funds, keeping FIIs happy is critical

India has seen nine consecutive quarters of positive foreign flows, quite likely a record of sorts. That trend was in danger of reversing in the three months to June but with the tax authorities pulling out all assessments and fresh orders, relating to MAT, it might not. Given how it is not even clear how much such a levy would fetch, the government would do well to abandon the idea of charging a retrospective tax on capital gains altogether. The finance minister had put out a number of R40,000 crore claiming he could fix the country’s irrigation system with the pickings but given the litigation coming the government’s way, it is doubtful the money would have come in easily and without animosity.

Already, patience is running thin because the government hasn’t been able to deliver as much as was expected, which, it must be said, was a lot. All output-related data is weak—whether it is production of steel and cement or even cars, which has just shown its first uptick in 30 months on a weak base. It is not surprising corporate earnings are anaemic; broad earnings in the December quarter were the weakest in 20 quarters, Sensex earnings in the March quarter are tipped to grow by just about 1%. More important, management commentary in the current earnings season—which has so far seen virtually every heavyweight disappointing—has been very cautious, an indication that a sustainable turnaround is some time away.

So, after having waited for a year, foreign investors who have been overweight in India by close to 500 basis points, and own the Indian markets like they have never done before, are moving money to other markets, notably China. This is not the best time to antagonise them; with the economy in poor shape, no matter what the GDP numbers say, the government’s tax targets look hugely optimistic and if the deficit is not to be breached, a successful disinvestment programme is a must. Selling R70,000 crore worth of stock isn’t going to be easy without FIIs even if LIC has a fat chequebook.


Whether one likes it or not, foreign investors have funded much of the capital that companies have mopped up in the past several years, even those of our banks. Without this capital there wouldn’t have been even the limited growth that one is seeing. This is not to sing a paean to FIIs, for sure; they are here to make money, but retrospective taxation leaves a bad taste in the mouth and puts off even the most committed investors. Which is why it is important the government gives up the thought altogether. That will reassure the FIIs and hold up the markets so that the chances of the share sales going through are better.

Let’s understand that capital, in whatever form, is going to be critical to revive the economy since the government doesn’t exactly have it in abundance; while it has budgeted for capital spends of R2.4 lakh crore this year—capex for the nine months to December dropped 13% y-o-y—these will only materialise if the tax collections do. If the private sector is going to spend on capacity addition, it is going to need to raise equity capital and that can either come from internal accruals or from the stock markets.


Given how leveraged companies are and how crimped cash flows are right now, there is no cornucopia of cash out there. The gross debt of the companies comprising the BSE 500 has risen more than 10 times since FY02 to R24.3 lakh crore in FY14; the interest cover, a Standard Chartered study showed, has gone down considerably and over a fifth of the firms will not have enough earnings to even pay interest over the year. In the post-financial crisis years, the increase in debt levels did not lead to a corresponding build-up in asset creation—which is why servicing the debt is going to be a real problem.

India Inc, the study points out, needs to raise $80-$90 billion in the next couple of year to restore the consolidated debt to equity ratio to 1.2 from 1.34 currently. There is very little chance of companies being able to mobilise this kind of capital given there isn’t any real improvement in profits.

In fact, there is a good chance some of the capital invested in projects will get eroded. Banks, who will be the biggest sufferers of this borrowing binge, are trying to salvage the investments made; the  5:25 scheme is one way to do this. But CRISIL anticipates that of the R80,000 crore or so that’s expected to be refinanced under these norms, 15% could slip. In other words, some more capital is likely to be destroyed in the near-term. In short, equity capital, already scarce, could continue to be in short supply. Under the circumstances, it would be foolhardy to discourage those who want to want to invest. Foreign investors may be disappointed with the pace of reforms—the Land Bill and the GST are still work in progress—but will willingly give the government a long rope on these since they acknowledge the government has made progress on other issues like, inter alia, FDI limits for insurance, construction and defence, auctions for coal blocks and norms for REITs. They may have started taking risk off the table, but will surely be back if they believe the government can deliver. India is still a good growth story, but would no longer remain so if it is going to be so taxing to buy into it.

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