India-Mauritius Treaty to have significant impact on Indian economy

The Indian equity markets fluctuated on Wednesday following the India-Mauritius Treaty which laid phased-out removal of capital gains tax exemption, making investors jittery. However, the impact did not last long, as the passing of the Bankruptcy bill in the Parliament on Thursday moved markets higher, recovering losses incurred on Wednesday.

The 30-share Sensex rose 0.47 pct to 25,716 on the Bombay stock exchange while the 50-share Nifty moved 0.44 pct higher to 7,883.05 on the National Stock Exchange.

However, the Mauritius Treaty, to be effective from Mar 2017 is expected to significantly impact clauses under the India-Singapore Treaty, as well, since, Singapore and Malaysia together account for almost one-third of  foreign inflows in to the country (assets under custody) and  over half of the inflows from foreign direct investment.

Domestic investors have been allotted sufficient time to analyze and institutionalize the likely impact of such a change in the tax structure, which may not have implications for a retrospective tax as well, lending major economic changes to the domestic industry.

"In fact there is likelihood that investment flows might be front-loaded to tap the current favorable tax benefits," said DBS in a recent research note.

In light of this situation, India’s recent accumulation of foreign reserves will help in the wake of sustenance to external shocks and cover the gradual rise in external debt. Total foreign reserves rose to a record high at USD 363bn by late-April, up USD 11billion from end of last year and rose to USD 16 billion from the lows earlier this year. Earlier this year, the authorities had dipped into the reserves to offset foreign equity outflows and defend downside pressure on the currency.

"We do not expect flows to dry up as tax benefits to investors will still accrue if held for longer, but short-term/ hot-money interests will lose the tax advantage," DBS said in a research report.