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A Reform Approach to The Policy Debate!

A Reform Approach to The Policy Debate!
1 Jul 2012

Towards the weekend, two major policy decisions hit the local and international media causing further credibility crises for India with respect to foreign investor sentiments and image. Whereas, the flip flop on General Anti-Avoidance Rules (GAAR) and retrospective amendments to tax offshore transactions (now patented as Vodafone tax) continue to hog media headlines, another one was the Foreign Investment Promotion Board (FIPB ) decision to turn down a FDI proposal for a JV between the Tata's retail business, Trent and Spanish clothing brand, Massimo Dutti.

Inherent contradictions have become a norm
Firstly, how such decisions get taken and the media strategy deployed to communicate runs contrary to the statements made by the new FM. So, we have a leader who probably would have been at pains at the G-20 meet in Brazil to convince the world leaders that India means business, that it will address roadblocks to reforms, that it will address foreign investors' woes, that it welcomes foreign funds investing in India, that a resolution to tax problems is forthcoming, etc. Back home, press releases by the Prime Minister's Office (PMO) is flooded with twitter posts echoing the same message and therefore, investors experience a brief cool breeze in the midst of a horrible summer. This is followed by news on rejection of foreign investment proposals, flip flop between the PMO and Ministry of Finance (MoF) on GAAR regulations, Capital markets Committee in Hong Kong issuing a threat that they would direct withdrawal of foreign institutional investments from India should India go ahead with its GAAR framework in the present form. What would be going in the mind of an entrepreneur (leave alone a foreign investor) who wants to invest? Leave alone business decision makers, experts are at odds explaining how policy framework works, how it is implemented and administered and if you disagree with a policy decision, all mechanism is in place to uphold the rule of law.

Discretionary authority has widened
Problems are plenty when it comes to doing business in our country. Let me focus on a few - there is too much discretion and latitude at every step of policy making and all steps to simplify them in the past two decades have merely lead to greater complexity. Take for instance, our policy for foreign investment which is dictated by press releases updated on a periodic basis. Attempts to consolidate and rationalise them have not taken away the discretion of policy makers. Take the policy in relation to enhancing the FDI limit for single brand retail and conditions associated with it. The policy says that 30 per cent of procurement shall be sourced locally. The FDI policy as announced was meant for luxury brands and it is known that none of the luxury brand supply chain and procurement standards will permit local procurement for reasons of quality etc. So, why have a policy that has a self-defeating objective? Let's not now send a confusing signal for enhancing FDI limit after debating for almost a decade; instead, it is better to not hike the limit - it becomes a credibility issue for the country otherwise, besides of course, it being discriminatory. Soon after the MoF presented the first draft of the Direct Taxes Code, a senior constitutional lawyer remarked that the new law empowered use of discretionary powers in over 100 instances, which should be discouraged. Similarly, a judge of the court based on a cursory look at the first draft opined that the new law was nothing but a haven for tax litigation. Though, we seem to have covered some ground in fine tuning the DTC, the question is are we ready for it and have all the glitches been addressed with a meaningful debate? Take UK's case for legislating GAAR - it took them 4 years of debate to finally nail down the intricacies of legislation and tax payers have been assured that the law will be invoked in exceptional situations with all forms of inbuilt safeguards and least scope for discretionary authority.

Leading to irrational decision making without accountability
The reason given by the FIPB to reject the Massimo's proposal is that its proposal is in violation of rules which prescribe that the brand should be owned by the investor. This is the most bizarre argument I have heard - if one is familiar with the group structure of the Spanish giant with revenues of over ^14 billion, a mere look at the website suggests that the group holding company Inditex owns several brands including Zara and Massimo. The rationale for rejection is that the investor does not own the brand! Take another instance of retail in FDI policy approved by the Cabinet and derailed by the ruling regimes coalition partner. The policy besides micro conditions prescribes that a certain portion of supplies would be sourced from local artisans, handicrafts, small scale industry. In substance, our policy makers are saying that India should dictate Wal-Marts, Ikeas, Tescos and Carrefours of the world how they should structure their supply chains including not just imposing conditions on setting up back-end infrastructure, but they should mandatorily procure from local artisans and if they don't, no approval will be allowed. Before we announce such policies, do we give a thought that such conditions are open to challenge in the Indian court as being unconstitutional on the grounds that they are discriminatory besides violation of right to do business freely? We tend to confuse multiple policy objectives and attempt to please all stakeholders. If Ikea wants to invest in India, each of their mega stores would probably cost them an investment of $5-$10 million and if that be the case, how do they become a threat to local suppliers? Incidentally, last week, Coke's chairman announced a multibillion-dollar additional investment in India. What message would he carry to his board? If the government worries about a rogue investor from a tax haven investing $10 million under the FDI retail policy, there should be a different mechanism to deal with it. A fundamental question, we should ask ourselves is, do we want FDI and if the answer is no, we should own up to it and announce to the world.

And, enforcement machinery is ineffective
Another hurdle is our enforcement and monitoring mechanism in general, and for FDI, in particular. After an FDI approval is granted, who is supposed to be enforcing it - is it the Ministry of Industry, the CAG or the local police station? Even if one assumes that conditionality's a noble intent, we never seem to address the last mile on policy - how is adherence to conditions monitored and how is a breach dealt with? If the overarching governing law is Foreign Exchange Management Act, which seems to be the case, the RBI becomes an adjudicator. Does RBI have the bandwidth to enforce FDI laws and is that what the country's central bank should be doing? To add to investors woes, there is no appellate process against the Reserve Bank's decision. So, where does Massimo appeal against the FIPB's order? Essentially, what we are saying to the Spanish giant is, take it or leave it - we shall deal with the alleged violation of bilateral investment promotion and treaty at an appropriate forum. At least, that's what the media headlines suggest.

Need to strengthen framework
What we as a country need is an institutional framework for policy formulation and credible policy debates. Policy is rarely debated in the House. Let Parliamentarians come in media to debate the policy. President Obama did the same with respect to health reforms, besides the US Supreme Court upholding it last week. It is not the sole prerogative of the legislators and the Executive to formulate and guide policy debates. Their role is to legislate and administer the law after a meaningful debate. It is critical for the government to strengthen the framework of think tank bodies and emergence of new bodies that contribute to sensible policy framework in a robust nation, which still has the world's attention. There is a lot of intellectual capacity within and outside of the government and think tank bodies such as NCAER, NIPFP, and ICREAR etc. How frequently do the law makers adhere to advice from bodies such as the Investment Commission, which are set up to address investor problems? Appointing a retired officer to commission a report on an important policy are frequent instances suggestive of the government's lip service to meaningful debates. India's policy debate cannot and should not have a temporary shelf life. As Dr Partho Shome, former advisor to the FM in his recent treatise opined that besides a separation of powers of policy makers and law enforcement agencies, we need at least 200 people in think tank of the revenue administration playing role of tax economists - just breathing, eating and sleeping tax policy, which would guide future of the nation.

After all, if we target to collect $200 billion as annual taxes and these figures are expanding exponentially every year, we should debate on the policy that will guide such objective.

Your Taxand contact for further queries is:
Mukesh Butani
T. +91 124 339 5010

First published in the India Business Standard, 2 July 2012




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