Voda case is less about right and more about might

The pressure is being piled on. Governments ranging from the UK and the US are said to be weighing in on behalf of Vodafone in the case of the proposed retrospective taxation of its offshore deal to buy the Indian telecom interests of Hutchison Essar in 2007.

For its part, Vodafone has invoked the Indo-Netherlands Bilateral Investment Treaty (BIT) to force the government to start a discussion with it - and find a way out before invoking international arbitration. The Economic Times reports that the government is unlikely to bite, and, in fact, the Vodafone notice under BIT is souring the relationship between the company and the government.

Questions have been raised about the morality of a retrospective tax, whether the Supreme Court will strike it down since it is an obvious attempt to nullify its Vodafone verdict, and whether the Indo-Netherlands BIT can be invoked in a tax dispute.

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These questions will be answered over the next few months as the courts sink their teeth into it once again.

[caption id=“attachment_283690” align=“alignleft” width=“380” caption=“The real problem with the Vodafone spat is that it comes at the worst possible time for us. Reuters”]  [/caption]

However, one point needs to be debunked rightaway: ultimately it is not about morality or fairness. In the global arena, might is right. If you are the US, you can armtwist anyone to get anything done. The US could force the Swiss to end their banking secrecy for US citizens. The Germans and the Brits did so too. If you are China, you can also do pretty much what you like.

As TN Ninan writes in his weekend Business Standard column: “The exercise of sovereign power (like taxation) is limited only by what you can get away with. China steals the intellectual property rights of virtually every company that invests in that country, and most of the companies just grin and bear it; the Chinese market is too attractive to boycott it in protest. China also indulges in large-scale hacking of computer networks around the world, it forces content companies ranging from Google to Rupert Murdoch’s News Corp to play ball on censorship, and it has a beggar-thy-neighbour stance on currency policy. Why? Because it can get away with it…”.

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If this is what it is all about, the question in the Vodafone case is not its morality or amorality, but whether India get away with it, given the kind of international pressure being brought to bear on the government to reverse course.

The real problem with the Vodafone spat is that it comes at the worst possible time for us - when the external account is under pressure, and the country needs all the foreign investment inflows it can get. We have run a huge current account deficit (CAD) at the worst possible time to think of Vodafone-like laws or imposing General Anti- Avoidance Rules (GAAR).

With CAD rising to 4 percent of GDP, it is quite clear that the rupee will be under pressure , and sooner or later the government will have to pursue policies that compress imports - either through a petro-fuels price hike or some other more drastic measures. In the short-term, we also need foreign exchange flows - and the signals we send on Vodafone will matter.

So the answer to the question whether we can get away with it depends on the following: what do we have to do to shake off the western pressure on Vodafone.

The answer is this: if India can somehow become a more attractive place for investing, the west will not support Vodafone at the cost of its larger interests in investing in India.

Can this happen, when Chief Economic Advisor Kaushik Basu has more or less said that no major reform will happen between now and 2014 - though he has since retracted and modified his statement?

How can India establish its might as right in the Vodafone case?

Again, it depends on what we do in India rather than what we do to convince others about Vodafone. Since 1991, we have pursued reforms reluctantly since we have sold it to our people as something that the foreigner wants and which we cannot avoid. Little wonder, there is no real constituency for reform - even though everyone has benefited from it, including the poor.

The 1991 and subsequent reforms have created a huge wealth-generating machine, and a new urban middle class. The revenues generated from the two have allowed the UPA government to redistribute the income to the rural poor. This has generated huge rural demand - though at the cost of high inflation and higher corruption.

The right response to the Vodafone challenge is to do reforms for ourselves this time, not the foreigner. They will come if our economy is doing well anyway.

The reforms we need are all internal:

One, we need to open up our internal agricultural markets so that middlemen are eliminated and both the farmer and consumer benefit. This can be done piecemeal - state by state. FDI in retail is less important that this internal reform measure.

Two, we need to free up our labour market so that companies see a point in hiring more. If labour can’t ever be fired, they will seldom be hired. Indian business has been raising the capital intensity of investment at the cost of labour. This will continue till labour reforms get underway. The answer is not a crude hire-and-fire policy, but a law to allow for firing when economically unavoidable.

Three, we need to prod our own pension funds to start investing in stocks. If we do this, with adequate safeguards, we don’t have to kowtow to the FIIs who complain about GAAR and P-notes. Our markets will be driven by our own money. Indians are the most underinvested in stocks - and this needs to change.

Four, we need to simplify our regulatory laws, and end inspector raj for the small and medium sector, the sector that creates the most employment.

Five, we must go ahead on electoral reform to control big-ticket corruption. State-funding of elections is important here and it can easily be financed without additional resources (See how here ).

Six, the more important question for any government to ask is whether it has the right policies in place to attract investment. It does not matter if the investment is domestic or foreign. The reason why foreign investment has become important now is because the government has lost the faith of even domestic investors. This is what needs to be fixed first.

There are many more things we need to do, but these are some good places to start.

As we said earlier, a country that wants to exercise its sovereign right to tax the daylights out of anyone, must have the internal strength to stand up to the world.

Does the current government have it?