Foreigners Sell Indian Equities in April as Tax Concerns Weigh By Shikhar Balwani - May 2, 2012

Foreign funds turned net sellers of Indian stocks in April, the first month of withdrawals in 2012, deterred by proposed changes in tax rules in the fourth-largest equity market in Asia outside Japan.

Offshore investors sold a net $102.6 million of local equities last month, data compiled by the market regulator yesterday showed. Funds, who were net buyers in each of the previous three months, have invested a net $8.76 billion into Indian shares this year.

“Long-term investors into India aren’t increasing their exposure as the horizon isn’t clear,” A.S. Thiyaga Rajan, a senior managing director at Aquarius Investment Advisors Pte. in Singapore, which has been investing in India since 1995 and has about $400 million in Indian assets, wrote in an e-mail. “First, there is uncertainty on tax. Second is the continuing depreciation of the rupee given weak economic fundamentals.”

Finance Minister Pranab Mukherjee proposed in March to introduce the General Anti-Avoidance Rule, or GAAR, to curb evasion of taxes by companies through misuse of tax treaties with other countries. Foreign funds are concerned the new rule may apply to their holdings of domestic shares, prompting U.S. trade and lobby groups to raise the matter in an April 17 letter to U.S. Treasury Secretary Timothy F. Geithner, who discussed the plans last month with Mukherjee.

India’s $1.2 trillion market is influenced by flows from overseas. The BSE India Sensitive Index (SENSEX) was the best performer among the world’s top 10 markets in 2010 when the nation took in a record $29.4 billion. The gauge sank 52 percent in 2008, its biggest annual slump, when withdrawals reached an all-time high. Flows into Indian equities this year are the highest in Asia outside of Japan after South Korea, which received a net $9.54 billion, data compiled by Bloomberg show.
‘Needs to be Competitive’

“India, with its current-account deficit, needs to be competitive when attracting global capital,” Adrian Mowat, the chief Asia and emerging-market strategist at JPMorgan Chase & Co., who has been investing in India since 1993, said by e-mail. “The country is unique in charging capital-gains tax to foreign institutional investors.”

India’s $1.7 trillion economy slowed for four consecutive quarters through December. Gross domestic product probably grew 6.9 percent in the year ended March, the least in three years, according to government estimates. The slowdown has sapped tax revenue even as subsidies spur spending, leaving India with the widest budget gap among the so-called BRIC group of biggest emerging markets that also includes Brazil, Russia and China.
‘Level-Playing Field’

The rupee weakened to a four-month low of 52.955 per dollar yesterday. The current-account deficit was $19.6 billion in the three months through December, the worst quarterly performance on record. Mukherjee in his budget speech on March 16 estimated the fiscal deficit at 5.9 percent of GDP in the year ended March 31 and sought to reduce the gap to 5.1 percent this financial year by raising taxes and proposing to cap a subsidy program.

“GAAR would help government revenues, but would do more harm in the medium term,” Adrian Lim, a Singapore-based senior investment manager at Aberdeen Asset Management Plc, said in an interview with Bloomberg UTV on April 30. “Foreign investors want a predictable, level-playing field.”

The proposed changes to tax rules, which will be discussed by lawmakers in the current parliamentary session, followed a ruling in January by India’s Supreme Court that Vodafone Group Plc (VOD) doesn’t have to pay $2.2 billion in tax on its purchase, conducted offshore, of the Indian business of Hutchison Whampoa Ltd. in 2007.

Vodafone, the biggest cell-phone company, has threatened to pursue international arbitration should India proceed with the plans. The operator’s Dutch unit served a notice of dispute to the government on April 17, invoking an investment treaty between India and the Netherlands.
Participatory Notes

The proposed tax provisions won’t apply to holders of participatory notes, or derivatives held overseas, Mukherjee said in March. Investments through the notes were 15 percent of 11.07 trillion rupees that foreigners had in stocks, bonds and derivatives at the end of March, data from the regulator show.

Participatory notes allow foreigners not registered in the country to invest in the stock market.

Macquarie’s Asia hedge fund has exited its short positions in Indian single-stock futures in response to the proposed tax rules, Reuters reported on April 23, citing a letter to clients from Nick Bird, the fund’s portfolio manager. The fund could become liable for tax on unrealized gains after April 1, while open positions in single-stock futures might also be liable, Bird told clients, according to the report.
‘Earnings Magnet’

The Sensex has risen 12 percent this year as foreign funds bought local stocks on optimism the central bank would reduce interest rates after record increases in funding costs eroded corporate profits. Earnings for four, or 33 percent, of the 12 Sensex companies that have posted results for the three months ended March 31, have missed analysts’ estimates. In comparison, 47 percent of the 30 Sensex companies lagged behind forecasts in the December quarter.

“Earnings seem to have bottomed and should recover from here on and that will be the magnet that will bring back flows irrespective of how the tax issue evolves,” Arjuna Mahendran, the Singapore-based head of Asia investment strategy at HSBC Private Bank, told Bloomberg UTV yesterday. “India offers global investors superior rates of growth. I can’t see large institutional investors, including us, departing because of this,” he said, referring to the proposed changes in tax rules.

The Bank of New York Mellon Corp. index of Indian American depositary receipts slipped 1.1 percent to 1,010.63 by 2:11 p.m. in New York, poised for the biggest one-day drop since April 23.

To contact the reporters on this story: Shikhar Balwani in Mumbai at sbalwani@bloomberg.net

To contact the editor responsible for this story: Darren Boey at dboey@bloomberg.net
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