Is India turning hostile for foreign investments?

Is India turning hostile to foreign investors?

To be sure, they have plenty to complain about at the moment. Especially since in the space of a few months, so much has changed.

Foreign investors had looked forward to the Union Budget to announce measures that would boost economic growth and encourage foreign investment.Instead, what they got is a Budget littered with proposals that seem determined to drive them away.

The most recent case of heartburn came from a budget proposal that allows authorities to crack down on “ tax avoidance ” under the vague provisions of the General Anti-Avoidance Rule (GAAR). Set to come into effect on 1 April, it put the burden on companies to prove that they didn’t structure deals to avoid taxes.

[caption id=“attachment_261408” align=“alignleft” width=“380” caption=“Local firms have become unwilling to invest in such an environment. The government is making sure foreign investors don’t either. Reuters”]  [/caption]

The proposal shocked and frightened foreign investors, many of who had invested in Indian stocks and bonds through companies set up in Mauritius to avoid paying capital gains tax in India. In addition, it threatened to tax holders of participatory notes (P-notes), derivatives used by foreigners to invest in India.

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On Friday, two days before the proposal comes into effect, finance minister Pranab Mukherjee clarified that the proposal would not cause any tax liability for holders of participatory notes.

Thank God for small mercies – because foreign investors have more bones to pick with the Budget.

A proposal to tax cross-border deals involving the transfer of Indian assets with retrospective effect (stretching all the way back to 1962) has also caused consternation, and threatens to drag Vodafone into another long-drawn battle with the government and overrule a Supreme Court verdict that said the British telecom giant had no tax liability on its offshore deal to acquire the Indian assets of Hutchison Essar in 2007.

The proposal, if passed, will also affect a host of multi-national companies, including Kraft Foods, SABMiller and AT&T.

Another Budget bombshell was a proposal to hike the tax on oil production. As it turns out, the only private company to be affected by this is Cairn India, owned by London-listed Vedanta Resources. Cairn India has complained that the tax increase will cost the company $2.5 billion and discourage plans for further investment.

Outside the Budget’s deleterious effects, internet executives from Google Inc and Facebook Inc are facing criminal prosecution for not removing web content that some consider objectionable even though the companies claim they have followed the letter of the law.

The brewing battle between UK-based The Children’s Investment Fund state-run Coal India also threatens to put the poor corporate governance standards of state-run companies in the spotlight - another negative for foreign investors.

Driving foreign investment away

It’s as if the government is trying hard to shoot itself in the foot. Faced with a yawning fiscal deficit and a current account deficit, the government is not doing itself any favour by trying to scare away foreign capital.

Late last year, faced with a cooling economy, the government went all out and rolled the welcome mat for foreign investors by introducing measures such as allowing individual foreign investors to invest directly in stocks and raising the cap on investing in corporate debt.

This year, it’s doing all it can to scare them away. The policy flip-flops are causing immense uncertainty and will put off investors seeking to make long-term investments. Worse, the faith in Indian courts to offer a final decision may also evaporate if the government initiates policies that overturn court verdicts.

The economy is already wheezing under the strain of high inflation, high interest rates, high oil prices and a weakening rupee. Local firms have become unwilling to invest in such an environment. The government is making sure foreign investors don’t either.

So, here’s our advice to foreign investors: Put your hard hats on, you never know when the government will sneak up from behind and hit you.