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Govt must not dilute know-your-customer norms for FIIs

Business Standard Editorial Comment  |  New Delhi 

As preparations for the 2015-16 Union Budget gather pace, Prime Minister Narendra Modi has been meeting the heads of various multinational companies, as well as representatives of major foreign institutional investors (FIIs). The meeting with FIIs was organised by BlackRock, the world's largest asset management company, and the selection was curated by BlackRock's indomitable co-founder and head, Laurence Fink. Mr Fink told The Wall Street Journal before he flew out with BlackRock clients to meet Mr Modi that "since he's been prime minister, their equity markets have pretty close to doubled. He's proposed many reforms that make it easier to do business in India, and now we need to see if he implements them all. There's a lot of hope that he will". The focus of the BlackRock clients who met Mr Modi, apparently, was infrastructure. By all accounts, Mr Modi responded with assurances that the issues dear to FIIs' hearts would be addressed. Greater clarity on tax issues would certainly be welcome. Automatic appeals against court judgments should cease to be the rule, and the recent decision not to take a judgment in favour of Vodafone in a transfer-pricing case to the Supreme Court speaks well of the government's intent. Transfer-pricing rules should be made more transparent, and there should be quicker and more independent recourse for companies that come under the taxman's scrutiny.

However, the government must not under any circumstances bend excessively to FIIs. The Indian financial markets already have far too many loopholes. Many tax-avoidance-enabling methods such as promissory notes and so on should have been shut down long ago. And know-your-customer, or KYC, rules, should not be relaxed arbitrarily. A more mature financial system would have clearer and more transparent KYC rules, not dispense with KYC rules altogether - though naturally investors would prefer the latter. The government must work hard to sift the reasonable demand from the unreasonable ones. One indication of the government's willingness to bend too far too fast when dealing with FIIs is its reported willingness to postpone the General Anti Avoidance Rules, or GAAR. There is legitimate fear that these rules, long postponed already, could enable further intimidation by the taxman. But the truth is also that GAAR-type systems are the future. They are the next step in flexible and modern KYC systems, which can speedily update themselves to new financial instruments in such a way that neither financial innovation nor tax revenue is hurt. Yes, they need to be accompanied with reform of the tax administration system: the panels that oversee the implementation of GAAR should not be staffed with tax bureaucrats, but other experts. This solution has been long known and understood. Instead of simply deferring such reforms, the government should be at work preparing the ground for them..

Read our full coverage on Union Budget

If the necessary calls on modernising the financial system are not taken now, then when will they be taken? The visit of the BlackRock investors should be seen as being a sign of India's strength, not weakness. Underlying Mr Fink's words to the Journal was the simple fact that not many other places have booming equity markets and the promise of returns in the way that India today does. India must reform when markets are at their highs and FIIs are nevertheless forced to be interested - because, obviously, reforms are more unlikely to happen on the occasions when sentiment is fragile. Business-friendly tax reform must be on the agenda, for the Budget, not the FIIs' demands for deferments.

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First Published: Wed, February 04 2015. 21:40 IST