Indian shares posted their biggest weekly losses in four months and market participants are bracing for more falls in the coming week, rattled by prospect of below-normal monsoon, subdued corporate earnings parade and controversial back-tax claims on foreign institutional investors.
For the first time since Prime Minister Narendra Modi took office nearly a year ago on the promise of reviving growth and creating jobs, his ambitious plans for the economy face a huge challenge from adverse weather conditions, particularly posed by the global phenomenon called El Nino that causes drought in some regions and floods in other places.
The India Meteorological Department this week forecast that the June-September monsoon is likely to be 93 per cent of the long-term average. The four-month annual rainy season is the lifeline of the country’s farm sector, providing the main source of irrigation. Erratic weather has already caused havoc to standing crops and a few hundred indebted farmers have taken their own lives this year.
Although agriculture contributes only about a fifth to India’s GDP, almost two-thirds of the country’s 1.2 billion people depend upon farm-related activities for their livelihood. In other words, a drop in farm-linked incomes in the rural heartlands would seriously dent demand for consumer goods and other industrial products.
Lower farm output can also light a fire under food prices, cause civil unrest and jeopardise the Reserve Bank of India’s threshold for inflation and reduce the scope for further easing.
“That will mean the RBI’s inflation target of 6 per cent by March 31, 2016, gets breached,” rating agency Crisil said in a report. “Also the RBI will have less leeway to continue its current easing cycle.”
Earnings setbacks
Shares in Infosys slumped six per cent on Friday after the No. 2 Indian software services exporter’s sales and profit came in below market estimates. Even a one-for-one bonus share announcement failed to cheer investors.
“Management believes the traditional IT services model is dying and a structural change is taking place in the industry with pricing pressure in commoditised services, necessitating newer growth avenues including acquisitions in areas like automation,” Karvy Stock Broking said in a report.
It reckoned that newer areas of revenue growth would take several quarters to show up on performance and cut its earnings per share estimates for 2015-16 and 2016-17 by 5-6 per cent and lowered its target price for the stock to Rs2,170. The share closed at Rs1,996.25, down 8.5 per cent on the week.
Smaller rival Wipro dived 11 per cent in the week after its earnings also disappointed investors.
Companies that depend upon domestic demand to drive their performance also face an uphill task with hinterland incomes under severe strain.
“Slowing rural wage growth in India, driven by lower government support and unseasonal rains, has impacted overall consumption in rural areas,” Goldman Sachs analysts Pramod Kumar and Sumeet Jain said in a note to their clients. “Within the autos space, demand for two-wheelers and cars has come under pressure given their meaningful rural exposure.”
On the other hand, lower raw material costs should underpin margins. Of the three auto segments, we find the commercial vehicle sector has the highest potential margin upside given raw material costs as a proportion of sales are two times higher than two-wheelers and cars. Goldman said TVS Motors and Eicher Motors were its top picks.
Tax risks
Given the circumstances, it appears that New Delhi has shot itself in the foot by allowing the tax department to rake up back-tax notices on foreign funds, based on its belated interpretation of domicile status of the investors.
Foreign institutional investors (FIIs), who own about $330 billion (Dh1.21 trillion) of Indian shares, have long been subjected to 15 per cent tax on short-term gains and 5 per cent on bonds, while long-term gains are free of taxes. Over the past few months, however, the tax authorities have slapped a claim for minimum alternative tax that companies domiciled in India are required to pay.
“Without question, the gargantuan demand of minimum alternate tax against FIIs is yet another example of Indian tax terrorism,” Arvind Datar, a senior lawyer at the Madras High Court, wrote in an article in the Indian Express, referring to back-tax claims estimated at $6.4 billion.
“These demands will certainly get embroiled in litigation for years, with negligible tax collection. Once again, our tax department will admirably succeed in repelling foreign investment and making India as unattractive as possible.”
As the funds began a sell-off, the government sought to calm the nerves saying that funds registered in countries that have tax treaties with India, such as Mauritius and Singapore, would not have to pay the back taxes. That left the Damocles’ sword hanging over other foreign investors in the lurch.
Datar says the tax department’s interpretation of domicile status is flawed. Foreign funds are required to open a bank account in India and appoint a custodian, to comply with the market regulator’s rules. The tax authorities have now used this to put them at par with domestic companies.
“If Infosys or Tata Motors opens a bank account or even has an agent in London, will it be treated as a British company? If an Indian investment company is required to operate a bank account in London because of the UK’s securities regulations, will it become an English company,” asks Datar.
Incidentally, Modi had pitched to end “tax terrorism” in his successful election campaign after retrospective tax demands on companies such as Vodafone during the previous administration halted foreign investments and gave a bad name for the country among large investors.
The top-30 Sensex and the 50-share Nifty fell 3.5 per cent each in their biggest weekly drop since December and closed at 27,437.94 and 8,305.25, respectively. Doubtlessly, time is running out for the government to clear the air decisively. Uncertainty about tax risks can drive investors away.
— The writer is a journalist based in India.
