Mukherjee knows his onions but will he deliver?

New York: Foreign investors generally don’t understand a word of what finance minister Pranab Mukherjee utters in his thickly Bengali-accented English but most concede he can deliver a pro-growth budget if he dumps his propensity to cling to populism.

“Mr Mukherjee may not have a MBA degree from Harvard Business School or be as suave as some of the past Indian finance ministers, but he knows his onions. He can be a deliverer,” a senior executive at US private equity group, Blackstone, told Firstpost.

“Mr Mukherjee has called for accelerating reforms in the past. If Trinamool Congress party’s Mamta Banerjee had not deep-sixed the proposal to remove foreign investment barriers in multi-brand retail it could have gone through,” added the New York executive who didn’t want to be identified.

Analysts say opening up the retail, defence, health and education sectors to foreign investors will boost investment flows. There is no doubt that some reforms linked to land acquisition, foreign investment rules and subsidies on fuel, are crucial to lifting investment and spending in an economy headed for its slowest growth in three years.

With capital inflows drying out due to global economic uncertainty, the Indian government is finding it harder to fund its gaping current account deficit. Under these circumstances, Mukherjee must at least try to be the deliverer. India traditionally runs a wide current account gap and relies upon heavy capital inflows to fund the deficit.

Last year’s budget proposal to allow foreign investors to invest in equity mutual funds was warmly welcomed in the markets. In January this year, India moved to allow qualified foreign investors to invest directly in local share markets to boost foreign capital flows.

India is now considering allowing individual foreign investors to directly buy corporate debt. Mukherjee will take a final decision whether to include the proposal in the budget, reported “The Economic Times.” India currently allows foreign institutional investors to buy a total of $45 billion of corporate debt. Of this, $25 billion is allocated for infrastructure bonds.

Friday’s budget may bring some changes in how foreign company-related transactions are taxed in India. Earlier this year, Vodafone Group Plc won a $2.2 billion legal battle against the tax department after the Supreme Court ruled that India’s tax laws didn’t provide local authorities the right to tax deals between offshore entities. The Supreme Court ruling was a setback for Indian tax authorities who argued that they had the right to tax Vodafone’s $11 billion deal to buy Hutchison Whampoa’s Indian mobile business in 2007 because the sale was of an Indian asset.

Earlier, India’s finance ministry said it was looking into whether Kraft Foods would have to pay taxes to Indian authorities in its $19 billion takeover of Cadbury in 2010.

Now the government “will want to plug this loophole,” Neeru Ahuja, partner at tax consulting firm Deloitte, Haskins & Sells, told The Wall Street Journal.

The finance minister may do so by introducing an amendment to the existing law to say that any overseas sale of shares of a company which has at least 51 percent of its assets in India will be taxable in India, Ahuja told the Journal.

Everyone is bracing at the prospect that Mukherjee may introduce a provision that gives huge powers to tax authorities to examine the motivation for transactions. It’s possible he may introduce what are known as General Anti-Avoidance Rules (GAAR) which gives tax sleuths the ability to question any transaction by companies and individuals which decrease the amount of tax paid to the government to ensure those transactions haven’t been done with an eye on just avoiding taxes.

GAAR currently stands as a provision within the draft of the Direct Tax Code bill but may be taken out and introduced in the finance bill, some experts say.

“The government’s primary objective at this point is to raise revenue. We have seen the ONGC auction, increased duties on precious natural resources, and various other measures. So, when it comes to the conflict between increasing FDI and increasing revenue, the latter will prevail. I’m certainly concerned that any implementation of GAAR would be flawed and such a measure would create the opportunity for rampant abuse, directly affecting investor confidence,” Krishna K Gupta, general partner in Massachusetts-headquartered Romulus Capital, told Firstpost.

“Under GAAR, almost any transaction could be called under question as the motivations behind transactions are often subjective. While this government wobbles under the weight of regionalization, foreign investors will remain skeptical of any reforms getting through in the country,” Gupta added.

After a disastrous performance in recent state elections, Mukherjee will be tempted to step up expensive vote-garnering welfare programs. But this budget is being seen as a “test” of the government’s political resolve to be less prodigal, spendthrift and implement reforms to rescue India’s economy which slowed to 6.1 percent in the third quarter of the financial year 2011-12. The third quarter’s dreary performance will probably drag India’s annual growth to around 6.5 percent when we desperately need to get up to 8.0 percent. Investors are honing in on this year’s budget to get a sense of the broader policy intent of the stop-go Manmohan Singh government.