Indian Budget Ruling Alienates Foreign Investors, Creates International Uproar

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South Korea’s Posco may yet count as a blessing India’s decision to, yet again, delay approval for the steelmaker’s $12 billion integrated steel mill and port complex in the eastern state of Orissa.

The project — first announced in 2005 — has been the subject of repeated delays due to India’s convoluted regulatory process and public protests over plans to clear more than 1,600 hectares of mostly forested land for the plant. The delay comes at a time when environmental delays to other power, mining and steel projects have heightened concerns among foreign investors over India’s unpredictable regulatory system, as an FT article explains.

It also follows the government’s decision in mid-March to introduce legislation that in effect reopens its $2.9 billion tax dispute with Vodafone, a move that has been harshly criticized by investment analysts and foreign trade organizations. Last week, a letter was sent to Indian Prime Minister Manmohan Singh from organizations such as the British CBI, the US National Foreign Trade Council, Canadian Manufacturers & Exporters, Capital Markets Tax Committee of Asia and the Japan Foreign Trade Council, among others, warning the changes have “called into question the very rule of law, due process, and fair treatment in India.”

The government’s statement in the annual budget comes after they twice failed, through the courts, to extract capital gains tax out of Vodafone after the international mobile phone operator’s 67-percent purchase of Hutchinson Whampoa’s Indian business in 2007. Both the high and supreme courts ruled in Vodafone’s favor, whether one believes morally the firm was wrong to use elaborate offshore vehicles to avoid the tax (a structure that would not be allowed in the company’s home base, the UK; at the time in India, it was not illegal).

Like governments elsewhere, India is struggling to balance its books as growth slows and the country faces nearly a $100 billion deficit (still less, in percentage terms, than many Western economies, it must be said) and sees a retrospective raid on corporate gains as a potential windfall. The problem is India desperately needs foreign investment if it is to maintain the rate of growth it has enjoyed in recent years; yet this raid on foreign firms is likely to scare away the very investors the country needs.

Growth slowed to 6.1 percent in the last quarter, the lowest in three years. According to a Telegraph article, Lloyd Blankfein, chairman and chief executive of Goldman Sachs, has reportedly savaged the rule change as an “unbelievable” move which “will hurt India’s image as a place where rule of law prevails.”

US companies likely to be caught in the move include SAB Miller and Kraft, but with the retrospective element said to stretch to deals done as far back as 1960, clearly the net will be almost too many global players to mention. The Indians are almost certainly likely to water down the rules in the face of unprecedented international opposition, but would be better advised to tighten up their regulatory regime to ensure future deals are structured in such a way that the correct tax obligations are factored in at the time the investment is made.

It is not necessarily tax that puts off investors as much as uncertainty that current rules could be arbitrarily changed at any time.

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