Context

The recent Economic Survey made a strong case for reducing uncertainty in economic policy.

Suggestions

• Investors, both domestic and foreign, favour consistent and predictable policy regimes.

• As the Survey noted, “surges in economic policy uncertainty increase the systematic risk, and thereby the cost of capital in the economy.

• As a result, higher economic policy uncertainty lowers investment, especially because of the irreversibility of investment.”

• The Survey also pointed out that policy uncertainty has steadily declined in India since the days when the term “policy paralysis” dominated public discourse.

• Recent events seem to have, unfortunately, reversed the trend.

Policy Implications of recent decisions

1. Income tax surcharge on super rich

• Take, for instance, the tax proposals in the Union budget. In an attempt to raise resources, the finance minister proposed to increase the income tax surcharge on super rich individuals and association of persons (AOPs).

• As many foreign portfolio investors are structured as AOPs, limited liability partnerships or trusts, the proposal effectively increased the tax liability of foreign investors as well.

• Faced with a backlash, the government reportedly considered issuing a clarification on the matter.

• But, later on, it stood its ground, instead advising FPIs to structure themselves as corporate entities.

• Amid the confusion, foreign investors pulled out thousands of crores in the weeks thereafter.

2.Tariffs

• Another such proposal was the decision to raise tariffs on several import items, with a view to protecting the domestic industry.

• The decision marks a departure from the post-1991 trend of a gradual lowering of tariffs — hardly a positive signal to send, especially at a time when India aims for greater integration with global supply chains.

• Such unpredictable tax policies, driven by short-term revenue considerations, will have long-term repercussions.

3.Borrowing through foreign currency loan

• Another example is that of the proposal to raise a part of the government’s borrowing through foreign currency loans.

• The domestic bond market welcomed the move, notwithstanding concerns raised by former RBI governors.

• Bond yields fell by more than 30 basis points in the weeks following the announcement.

Conclusion

• While there has been no official announcement on the bond issuance following the bureaucratic reshuffle, the uncertainty surrounding it has pushed bond yields by as much as 12 basis points.

• Such uncertainty undermines the ability of investors to take informed decisions.

• Reducing policy uncertainty is critical for maintaining the country’s attractiveness as an investment decision, else capital will simply move elsewhere.

• The government would do well to pay heed to its chief economic adviser.