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Indian economy waits for dose of optimism
THE euphoria is over. India's business community had welcomed the re-election of prime minister Narendra Modi in May, but it is becoming critical of his government's policies just three months later.
There was widespread disappointment when the government raised income tax and imposed new taxes on share transactions in its 2019 budget announced in July.
A sense of jubilant anticipation that the prime minister would usher in reforms has quickly evaporated. The Sensex stock index has been declining since July when foreigners pulled more money out of Indian shares than they had invested.
The markets have been responding badly to the budget, which imposed a new 20 per cent tax on share buybacks, taking the capital gains rate above 40 per cent, which is among the highest in the world. Investors were further spooked because a tax on dividends and a recent levy on recipients would raise total taxes even more, to around 60 per cent.
Indian investors were deeply disappointed by a Budget provision to raise taxes for high earners from 35.9 per cent - which was already higher than in most emerging economies - to 42.7 per cent, which makes it about the same as in the rich and advanced countries. Major companies were not happy either as they saw their corporate tax rate maintained at 35 per cent, compared with a global average of 23 per cent.
These measures had the immediate effect of transforming the large buyers of Indian stocks into sellers. Investors pulled US$1.8 billion out of Indian stocks in July.
Unruffled by the exodus of funds, the finance minister, Nirmala Sitharaman, declared on July 18 that the new taxes would not have an adverse impact on investor confidence, claiming that fears of capital flight were unfounded.
"The super-rich should contribute more to society and nation-building", and foreign portfolio investors "should consider the option of structuring themselves as companies rather than trusts to avoid paying the increased surcharge announced in Budget 2019", Ms Sitharaman stated during the debate on the Finance Bill in Parliament.
For the "super rich" with annual income between Rs 2 crore (S$386,000) and Rs 5 crore, the new surcharge is 3 per cent, and for incomes above Rs 5 crore it is 7 per cent. The move has caused several companies to delay their plans for buyback of shares.
As the markets remained in turmoil, Ms Sitharaman met with foreign portfolio investors on Aug 9, but she gave no indication that she would withdraw the new taxes. Representatives of the 18 global investment banks who attended the meeting - such as Goldman Sachs, Deutsche Bank, Standard Chartered, and JP Morgan - received no assurances.
But according to Reuters, the government is considering an exemption for foreign investors from the tax increases. Analysts do not expect a complete rollback of the new taxes, but they anticipate that the government may lower the burden of the Long Term Capital Gains (LTCG) tax.
The stock markets paid more than Rs 11,000 crore in Securities Transaction Tax (STT) to the government in 2018. Besides this, they must pay the Short Term Capital Gains (STCG) tax, the LTCG, as well as the Goods and Services Tax to the central government, and stamp duty to the state government.
On top of all this, Ms Sitharaman raised the peak rate of LTCG and STCG to 14.25 per cent and 21.37 per cent, respectively, in a move that affects a large number of foreign portfolio investors, high net worth individuals, and institutions in India. Earlier, the peak rates were 11.96 per cent and 17.94 per cent for LTCG and STCG, respectively.
By imposing a new 20 per cent tax on buyback of shares, the government has ensured that a method of generating large trading volumes and liquidity may dry up.
If businessmen are no longer optimistic about the financial markets - their emotions range from worry to anger - the broader economy too is crying out to be rescued.
India's economic growth during January to March 2019 slowed to 5.8 per cent. Given the overall downtrend, it is likely that growth in the following period, from April to June 2019, may be even slower. It was already worrying that growth had declined to 6.8 per cent in the 2018-19 financial year, the slowest pace since 2014-15. The previous low was 6.39 per cent in 2013-14, after which the Modi government came to power in 2014.
The slowdown is largely due to sharply plunging consumption, which constitutes about three-fifths of the Indian economy. All the parameters of consumption have slowed except for retail loans given by banks.
Automobile sales, for example, plunged almost 19 per cent in July, hitting a 19-year low amid worries that a prolonged slump in this key sector is a symptom of deeper problems in the economy. Passenger vehicle sales fell for nine consecutive months amid financial woes of the automakers, some of whom laid off workers or temporarily shut down factories. Any decline in car sales reverberates through the economy, negatively affecting an entire chain of ancillary industries that support the carmakers, from steel to tyres.
At the core of the crisis in consumption is worsening unemployment that hit a 45-year high in 2017-2018. The country's working age population is expanding by 13 million a month, and not enough jobs are being created. The unemployment rate rose to 7.9 per cent in June 2019 - its highest in 33 months.
Housing sales are also in the doldrums, according to real estate research firm Liases Foras. There were as many as 1.28 million unsold housing units in India's top 30 cities in March 2019 - 7 per cent higher than in March 2018, when the number of unsold units was 1.2 million. Since the real estate sector is linked to more than 200 ancillary industries, from cement to paint, all of them rise and fall with its fortunes.
The sale of consumer goods, from biscuits to breakfast cereals, has slowed down. This indicates that many Indians are thinking twice before buying even a small pack of biscuits worth Rs 5, according to a senior executive of a large consumer goods' company.
Alarmingly, the value of new investment projects announced in the period April to June 2019 plunged by almost 80 per cent year-on-year, representing the biggest fall since September 2004, and investment projects completed fell by 48 per cent over the previous year.
The financial markets and the broader economy thrive on optimism, and are waiting for the government to restore that vital ingredient.
- The writer is editor-in-chief of The Calcutta Journal of Global Affairs.