RBI should be held to higher standards
On 7 February, the Reserve Bank of India (RBI) held its sixth bimonthly monetary policy meeting, and the last for the financial year ending March 2018. Coming within a week of the finance minister presenting his budget for 2018-19, it was expected to give us clues about what the RBI thought of the budget and its growth and inflation implications. Separately, stock markets around the world—even in places where the government of the day had not imposed any tax on long-term capital gains (LTCG)—had declined. Fear and uncertainty were beginning to creep back into minds long lost in complacency and risk-love. It was not the occasion for the central bank to strut its anti-inflation credentials. To its credit, the monetary policy committee left interest rates unchanged and said that it was sticking to its neutral stance. That is as it should be.
However, in the press conference that followed the meeting, the RBI governor proceeded to mar this near-blemishless conduct. When asked to comment on whether the investment slowdown in India had ended, he said India faced five different taxes on capital, including the LTCG tax, and that this state of affairs would certainly affect investment. Thus, the governor made an unacceptable foray into fiscal policy, which is the domain of the elected government. In fact, one could even argue that the answer was wrong because the question was about the investment slowdown in India at the margin in the last few years and not about the factors that influenced capital formation in general.
First, the finance minister has just proposed the LTCG tax in the Finance Bill. It is yet to be voted upon by Parliament. The matter is thus “sub judice” and, in that situation, it was wrong on the part of the governor to comment on it.
Second, most of the taxes he mentioned have been around for years, if not decades. Only the LTCG tax on stocks has been reintroduced. Importantly, the tax has been there for other assets for quite some time. If anything, for no valid economic reason, stock investors were being treated unduly favourably while real patient capital is taxed at 20% and then too you have to wait for 24 months to qualify for that rate. This government has reduced the holding period from 36 months to 24 months for capital gains to be deemed long-term. Stock investors have to hold only for 12 months and then sell to qualify for the low 10% tax rate on long-term capital gains.
Third, this government has been systematically raising the tax threshold on corporate taxes. It announced its intention to lower the top corporate tax rate to 25% in the 2015-16 budget. Then, in subsequent budgets, it has gradually raised the gross income threshold from Rs5 crore to Rs50 crore, and, now, in this budget, to Rs250 crore. Thus, it has been moving in the right direction and has also announced the phased withdrawal of tax exemptions, as promised. Commentators, including yours truly, have given less credit to the government than it deserves on this count.
Where this government has made a mess—or, rather, not undone the mess bequeathed by the previous government—is with respect to “angel tax”. It is a tax in the hands of start-ups that receive ‘angel funding’ from domestic residents. It was introduced in 2012 by a government that was headed by someone with a doctorate in economics from Cambridge University and continued by a government that wants India to start up and stand up. Strange, but that is a separate story.
Now, let us examine the RBI’s own culpability with respect to the investment slowdown. The slowdown is substantially the consequence of the twin balance-sheet problem in India—of banks and companies. Strictly speaking, the RBI is hamstrung from regulating government-owned banks but its jurisdiction over privately owned banks is not disputed. Privately owned banks too had, and still have, non-performing assets and some of them had even been understating them for years before the central bank detected the practice. In other words, there is need for an open and honest debate on the efficiency and effectiveness of RBI regulation of the banking system.
The Economic Survey 2017-18 points out that India’s investment slowdown has been long and deep. International evidence suggests that recoveries from such slowdowns are shallow and prolonged. In such circumstances, low interest rates hardly matter for corporate investment decisions, especially when enterprises have impaired balance sheets. That said, raising interest rates in this environment can hurt. Policy has asymmetric effects on the real economy.
Yes, there is the pesky detail of an inflation target. But policy rules are meant to serve public interest and not stand in the way of it. Near-religious and context-free obsession with higher interest rates and the inflation target is as harmful as the western world’s blind faith in the efficacy of low interest rates and quantitative easing. The decision of one internal member of the monetary policy committee to vote for a rate hike in the February meeting makes one uneasy about the bank’s model of the real economy.
Advanced nations have been ill-served by placing central banks, central bankers and monetary policy on a pedestal. India should avoid repeating that mistake. Public interest will be better protected if experts and commentators hold the RBI to the same standards that they apply to the government.
V. Anantha Nageswaran is an independent consultant based in Singapore. He blogs regularly at Thegoldstandardsite.wordpress.com. Read Anantha’s Mint columns at www.livemint.com/baretalk
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