Taxes, prices and restructurings: Moving ahead in the times of corona

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TAPONEEL MUKHERJEE | 24 May, 2020
As economies slowly open across the globe, the ramifications of the coronavirus pandemic on global trade and geopolitics are gradually playing out. Amid rapidly evolving global trade dynamics, India's focus on attracting manufacturing firms to India is a step in the right direction. That said, an area of even greater focus for India must be on freeing up capital flows in the economy. Essentially, while targetted focus on attracting manufacturing businesses to India is commendable, creating an environment that allows greater and smoother capital flow must form the core underpinning for India to generate economic growth not just in the near future but for the coming decade.

As with corona affected countries, India needs first to ensure that businesses can recover from the exogenous shock. In the long-run India requires to provide capital for both consumer and infrastructure businesses to expand. While the economic package announced by the Honourable Finance Minister has addressed some of the issues businesses face today, going forward further steps detailed below will significantly assist in generating growth and prosperity.

India will have to take a long hard look at the indirect tax rates in the economy. Reducing indirect tax rates in the face of a lower pandemic induced tax collection is challenging, however, a lower and simplified tax regime in the indirect tax space will have to come sooner than later to provide businesses with the boost they need to capture a higher component of the demand by passing through the tax cuts. Lower indirect taxes would aid businesses of all sizes and more importantly provide enterprises access to the excess capital needed to tide over issues and manage a period of low demand and supply-side shocks.

Boosting capital flow will also require the policymakers to allow market pricing where possible. Avoiding price controls, unless necessary, will be essential to create an environment whereby capital is encouraged to seek attractive risk-adjusted opportunities. Keeping price-controls to a minimum is vital not just to make Indian investment opportunities attractive for foreign capital but also for domestic capital.

Mainly, the ramifications of price controls must be carefully viewed if they were to make sectors unattractive from an investment perspective. A lot of the growth and investments that India received post the 1991 liberalisation was on the back of allowing markets to determine the price, thereby ensuring investors that capital deployment would accept a market-determined return. Lessons from history must be kept in mind as we move ahead. Additionally, the extension of the moratorium for loan payments by the Reserve Bank of India (RBI) is a welcome step that will allow people some breathing space as the economy stabilises.

That said, a mechanism that will enable for restructuring credit portfolios and loan books post the moratorium period is vital to ensure that adverse credit situations can be deftly sorted. That loan defaults will pick up in a tight credit cycle due to the corona induced slowdown is a given. The issues must be dealt with quickly to ensure that the contagion effect of a weak credit market is avoided.

The need to resolve credit issues is vital since the credit markets stand on a structure of asset-liabilities implying that the primary role of financial institutions that lend is that of an intermediary. Therefore, if an individual is unable to service their home loan, there could be a depositor with an NBFC or a wholesale lender that will eventually have to take a haircut on their investment return from their loan portfolio. While in a tight credit market, such situations will arise and must be understood to be a natural concomitant of credit markets, quickly resolving the issues assumes great importance.

Resolving credit issues is even more important when one looks at how important the credit markets have been towards the growth of housing, vehicle ownership and consumer goods ownership in the country. Well-functioning credit markets are needed to ensure that more and more consumers can get access to credit at attractive rates, thereby creating a virtuous cycle. The coronavirus induced slowdown has provided us with an opportunity to expedite reforms that can truly unleash the real potential of India. Given both the infrastructure financing needs that India has in the decades to come and a young population that can potentially power a mega consumer-driven economy, allowing businesses to flourish will be crucial.