Sense and sensibility

A two-tier market could strike a balance between growth and social obligations

By Mohan Sule

The Supreme Court’s recent assertion that making policies is the domain of the legislature should go to scotch the increasing concern over judicial overreach. Hopefully, the government would stop abdicating its responsibility of taking unpopular decisions by letting the judiciary take a call. However, the rider that the government’s actions should be motivated by “public good” is open to interpretation. Past experience forms the basis of most laws rather than anticipation of future developments. Regulation to discourage dividend stripping was formulated after its rampant prevalence. Take a recent case that has raised lot of heat. Vodafone of the UK has contended it is not liable to pay capital gain tax on purchase of the shares of Hutchison of Hongkong in the telecom services joint venture with the Essar group as the agreement was executed outside India. The income tax department expected the British company to deduct tax at source while paying the seller. The Supreme Court upheld Vodafone’s argument, thereby sticking to the letter but undermining the spirit of the law formulated to tax gain on sale of Indian assets. The loophole was subsequently plugged by amending the Income Tax Act, 1961, to include earlier deals. Foreign investors raised a storm, forcing a government desperate for capital inflows to rethink the legislation. The proposal to tax entities registered in tax havens has been postponed for a year. This has given rise to two contradictory scenarios. Revision in law was essential to avoid India being viewed as a tax haven and also to tax transactions that had escaped the net. At the same time, retraction from the stand to make the rule effective retrospectively was also necessary to avoid giving the impression that India was a banana republic that tinkered with laws depending on current circumstances rather than to impart stability. Both the stands taken by the government were for the good of public.

Leaving the formulation of the methodology to the discretion of the government, the apex court also ruled that auctions is not always the best method to dispose of natural resources, a nod to the argument that the high price to win gets embedded into the end service or product. In 2008, the winning bids for second-generation spectrum were determined as per a cutoff date, rather than solely on the criterion of financial standing and the value of bid followed in the earlier process. The restriction on number of players per circle was removed. In retrospect, this arrangement seemed to serve the purpose of intensifying competition and pushing down tariffs, which can be said to be for the good of public. Initiating an auction would have limited the number of players. Yet, after a transition phase, auction does look a suitable method to award the right to offer connectivity as users make a leap to the next generation of services. The need is for reliable suppliers with a wide coverage rather than providing patchy network at low cost. This means that the concept of public good is not static but evolves as the complexion of the market charges.

Precisely for the fluidity in its characteristic, the idea of public good is troubling. West Bengal chief minister Mamta Banerjee insists that subsidized fuel is in the interest of public, while the aim of Prime Minister Manmohan Sing and Finance Minister P Chidambaram is to puncture the ballooning fiscal deficit, which forces the government to borrow from the market to pay the producers, thereby hindering the Reserve Bank of India’s efforts to reduce interest rates, which is also for public good. Public good also includes employment generation. Jobs are created when companies undertake expansion to meet growing demand. Capital expenditure will be earmarked when the only risk is market perception and not uncertainty in policy making. There is no point for a generator to buy coal at market rates if the price of power is capped or for a pharmaceutical company to spend on research and development if it is unable to earn a decent profit margin. Besides consumers even shareholders form an important part of public. The challenge is how to balance this conflict of interest. By pronouncing that public good rather than maximization of revenue should be the pivotal of any policy to sell natural resources, the Supreme Court has ushered more confusion than clarity. A practical way out would be too create a two-tier market: one by state-run organizations assigned subsidized resources, so that they can provide affordable services and products; and the other consisting of private players competing for raw materials and consumers based on pricing, quality and service.

Mohan Sule

The countdown begins

It will not be premature elections but the health of the euro zone and the US economy that will drive the domestic market

By Mohan Sule

The UPA-II government’s rapid-fire reforms last fortnight will hasten its end. Even without any major policy initiative, foreign investors had started coming back to India since the beginning of this fiscal, lifting the broad market by nearly 19% till 14 September. Suspension of the General Anti-Avoidance Rules that aimed to tax foreign investors registered in tax havens for one year had improved sentiments. Liquidity injection by the European Central Bank and the US Federal Reserve had boosted global markets. As such the government could have just focused on day-to-day survival without shaking off its policy paralysis. Yet, unpalatable prescriptions such as increasing prices of fuels and opening up sensitive sectors for foreign direct investment were revived. The question is why now when any reform would have exposed fissures among coalition partners at a vulnerable time, with the government under attack for corruption. The first reason could be that the Commonwealth Games and the 2G spectrum and coal block allotment scams have pulled the stock of the UPA-II government to a bottom and nothing else could inflict any more damage. Second, various welfare programs including the rural employment guarantee scheme have boosted income in the hinterlands, as testified by the contribution of these regions to the top line of Indian Inc in the first quarter of the current fiscal, and increased their capacity to absorb small doses of hike in prices of diesel and LPG. Third, by dithering over opening of multi-brand retail to FDI, the Congress was unwittingly protecting the interest of mom-and-pop shops, which constitute the vote bank of BJP. Fourth, two of its supporters, the TMC and Samajwadi Party, have emerged from state elections recently and would not be in a position to fight mid-term polls now due to fatigue, depleted war chest, and a very short window for their policies to percolate to the grassroots.

In the meantime, the feel-good factor unleashed by the structural repairs could even be consolidated, providing Congress a chance to kick the winning goal. By then the various scams would be a distant memory for the voters just as the Bofors payoff did not deter them from giving Congress two consecutive terms. The euphoric reaction of the market has emboldened the government to dust off PSU divestment, another controversial measure, whose suspension was bolstering the constituency of CPM, which had withdrawn support to the UPA-I government after the signing of the US-India nuclear deal three years ago. Meeting the mop-up target of Rs 30000 crore would add fuel to the rally as the government would not have to divert funds from other sources to meet its welfare schemes, thereby reducing fiscal deficit. The success of the first batch of PSUs could also encourage the Reserve Bank of India, which retained the repo rate but reduced the cash reserve ratio last fortnight, to loosen up some more, thereby providing another boost to the stock markets, a winning combination indeed. But at hindsight, the risky gamble looks more like a self-inflicted wound by Congress rather than a masterstroke.

First, the positive impact of employment generation due to increasing the cap in retail and opening of the aviation sector to FDI could be visible over the long term. On the contrary, the adverse effect of hike in some petroleum products would be felt immediately. Second, it would be tempting for the allies of the Congress to distance themselves from the UPA government and covertly co-opt the opposition to precipitate elections before they become closely identified with unpopular but necessary decisions to bring the economy back into shape. In fact, by undertaking the bitterly contested reforms Congress has handed a gift to the opposition, who would be in a position to ride the discontent and at the same time saved from taking these very steps that would have become necessary if they were to form a government after the next elections. Does this mean that all the gains that the market has notched up would be wiped out if polls were to be announced before schedule? Not likely. Even a Third Front government with a regional leader at the helm will find its flexibility for posturing severely limited in the face on high interest rates and slow growth. More than domestic events, the availability of liquidity with foreign funds will dictate market trends. Another favorable indicator is the uncertainty in China. Its export-oriented economy is slowing down with unresponsive Europe and the US. This should keep prices of commodities down for India, with a little help from the appreciating rupee. For all the show of strength, history would judge Manmohan Singh as a reluctant warrior who picked up the gauntlet too late.

Mohan Sule