Is there anybody out there?

Now this is the type of announcement you can expect from the Finance minister of the sixth largest economy in the world. What a move!! Truly impressed even though I got crushed on my positions as a direct consequence of this sudden announcement.

While this will impact the fiscal deficit in the near future, it is likely to boost economic output and also result in an increase in compliance. For many businesses the cost of evading taxes may not be worth it anymore. Also this is a big "Welcome to India" sign for global firms struggling with their supply chain management due to the disruptive trade war.  

But, with this, I do have a laundry list of things I hope to see now, if anyone cares to listen!!

1. Tough penalties for non-compliance - Lower taxes coupled with a high cost of non-compliance would ensure that the tax base automatically increases, hence offsetting a part of the fiscal burden of this tax reform.

2. Maintain the taxes on share buybacks - Trump's tax cuts earlier in his tenure, coupled with low interest rates in the US, led corporate America to use the extra cash and cheap credit to buy back their own shares leading to, what many describe as a massive stock market bubble. Company executives are usually incentivised to increase the company's 'Earnings per Share' and stock buybacks have offered a sneaky way to achieve it without any real growth. Policy makers in India would do well to avoid this situation. A key objective of this tax reform would be the generation of real economic activity due to deployment of the free cash, generated by this tax cut, back into the business. Unchecked stock buybacks may instead just inflate a stock market bubble. That, in my opinion, would just create an illusion of prosperity and disproportionately benefit the top tier of investors at the expense of the masses and does not benefit the economy at all. Of course in India, fortunately, credit is not super cheap as in the developed world and therefore leveraged stock buybacks would be expensive.

I got a bit worried when I read somewhere that the finance ministry had removed the tax on stock buybacks. To my relief however, I learnt later that they had granted exemptions to buybacks that were announced till July 2019 but which have not been completed yet.

3. Prudential Monetary Easing by the RBI - The Repo rate in India as of September 2019 is at 5.4%. While I am not qualified enough to comment on the appropriate level of interest rates in our economy, intuitively I feel there has to be a credible cost of money in any healthy economy. For comparison sake, the base interest rates in the BRICS countries vary from 4.2% (China) to 7.5% (Russia). India currently falls towards the lower end of this range. US fed funds rate stands at 2% while most of Europe and Japan are experimenting with negative interest rates.

In my opinion the RBI should be prudent with its rate cuts. It would politically be a lot easier to cut interest rates than to increase them. Many analyst believe that minor interest rate cuts do little for the economy other than boost short term market sentiments. I feel that the RBI should have enough room for evasive maneuvers during crisis situations. Back in 2007-08 when the global financial crisis was unfolding, the Fed dropped their rates from 4.75% to 0.25% within a period of 15 months to manage the situation. Many believe that at the current levels in the developed world, there is little or no room for such measures to be effective (well one could argue that the rates could go even more negative but nobody knows how that will end).

Also I am amazed at how the media and the stock market latches on to every word uttered by the RBI Governor. A decade earlier one might have been hard pressed to someone who even knew who the Governor was. The RBI has a huge role to play in the economy in terms of managing the monetary policy, inflation and regulation of the banking system in India but it is certainly a fallacy to expect the RBI to steer policy decisions towards propping up the equity markets.

4. Regulation of credit card interest rates - While the RBI is taking steps to ensure that the rate cuts reach the retail loan customers, I wish the regulator took a closer look at the exorbitant interest rates charged by banks on credit cards. Credit cards are clearly a great business for the Banks, going by the aggression with which they are sold to the retail customers. However its ubiquity and ease of use has the potential of creating a massive debt trap for individuals. Even Shylok would be really impressed with an interest that ranges from 35% to 42% p.a.

5. Reduction of Income Tax - Clearly I am biased towards this agenda. However while the reduction in corporate taxes is expected to have a direct positive impact on investments and is likely to first increase supply and later demand, reduction of income tax would most certainly drive up consumption and hence demand in a big way. Similar to the reduction in corporate taxes, a reduction in income tax (along with severe penalties for non-compliance) is likely to increase the tax base (for which there is an enormous potential), hence offsetting the losses in tax revenue. In my opinion, this is certainly a better option than any monetary easing, either in the form of quantitative easing or interest rate cuts, if economic growth is the true objective.

And finally..

6. Reduction of tax rates for foreign companies and branches of foreign companies - Again I am a bit biased here. But foreign companies and branches of foreign companies are, at present, taxed at an effective rate of about 43%. This seems excessive specially when compared to the reduced corporate tax rates. This can be a deterrent for global companies to set up operations in India.

To conclude, India has always been known as "almost China but not quite", the emerging market with potential and a large population but with a history of reforms that tend to move at a glacial pace. This tax reform has the potential to change that perception.

If we are able to achieve a stable currency and an investor friendly economy, our growth potential, market size, relatively higher yields and favorable demographics may be able to attract the flight of capital in the current global scenario where capital is desperately seeking yield and traditional supply lines are getting fractured. We may well be staring at the greatest opportunity in decades.