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Growth means change and pro-active change does involve taking calculated risks for the greater good. Consider, for instance, policy change and reform, which is key to India sustaining the economic growth momentum. The Budget needs to draw up a road map for tax reform and attendant operational changes in vital sectors like banking and financial services. As the recent high powered committee on making Mumbai an international financial centre emphasised, we have indeed dismantled an “autarkic license permit raj” in industry and trade; but we need to do it again in finance. It would step up efficiency and productivity across the board, and lead to better allocation of resources.

The way ahead is to have a tax regime in finance that does away with cascading rates, induding stamp duty, registration duty and the securities transaction tax. Instead, what’s required is sound tax design for a goods and services tax (GST) in finance. Given the practical difficulties in having in place a comprehensive GST for financial services, a staggered, multi-year approach needs to be followed through. And once such a tax regime is in place, it would be simultaneously possible to remove turnover taxes, induding stamp duty and SIT. Perhaps the finance minister needs to announce that a technical committee would be set up to work out the mechanics and logistics of going about it.

There’s a case for tax reform when it comes to the consolidation of accounts. As per Indian GAAP norms, a listed holding company has to present stand-alone and consolidated accounts. But for income-tax purposes, such consolidation of accounts is not permissible. However, at a conceptual level, it cannot be said that it is desirable to tax a group on the basis of its ‘overall financial performance.’ The idea is to incorporate the performance of all subsidiaries taken together. In jurisdictions abroad, induding in the UK and the US, the standard practice is to levy tax on a corporate group’ as a single unit.’

There are other anomalies in the tax treatment in finance. For example, when a subsidiary company pays dividend to its holding company, it pays a dividend tax of 14.025%. But a dividend payout by the holding company to shareholders means a ’second dividend tax of 14.025%.’ So the tax code thoroughly disincentivises the ‘holding company structure.’ Now, the aim of a holding company route is to support listing and operations of a set of finance companies that may span the entire gamut of financial services. Bur the fact remains that Section 297 of the Companies Act ‘constrains the utilisation of the services of any group company by another.’ And even when group companies have a common management structure, ‘prior approval’ of the centre is necessarily warranted to unlock synergy. It suggests excessive and quite needless oversight. Instead, what’s needed is adequate provisions for transparency in corporate governance procedures. There are still other aberrations in Indian finance.

The most important’ deficiencies’ pertain to the absence of efficient and liquid bond, currency and derivative markets. The latter would include credit, interest rate and currency futures and options. All three markets need to develop rapidly with domestic and overseas participation. It would mean vigorous trading in the spot and futures markets, with much possibility for arbitrage opportunities to guarantee transactional liquidity in the marketplace.

The objective ought to be to chalk out a more realistic yield curve that shows the term structure of the going interest rates. A vibrant yield curve is a key signaling device in the mature markets. So the continuing absence of sufficient depth in the corporate bond and government securities market, together with shortcomings in the trading of currency and derivative instruments, does stultify informational and everyday operational efficiency in finance.

The lack of modem financial markets is actually counterproductive when it comes to public debt. For, in financing the fiscal deficit, a credible system requires that sovereign and sub-sovereign bonds be bought ‘voluntarily by any kind of buyer: sans coercion, direction and restriction. And this is far from the case at present. It needs to change. After all, a sophisticated financial system requires an active sovereign bond market as a ‘credit bellwether.’ As the high-powered committee report concluded, the asset portfolios of banks, insurance companies and pension funds are much ‘repressed’ by fiat at present. With dear-cut financial sector reforms and opening up, the three sectors are likely to ‘grow dramatically.’ In tandem, it will imply new sources of demand for government securities. However, if greater demand for the bonds is not matched by increased supply, the prices of such gilts’ should rise with the coupon rates suitably reduced. It would mean more efficient financial markets. The Budget needs to set the ball rolling for the much needed financial sector reforms.

In the past, there was only one way the Indian rupee moved against the dollar and the other high currencies. Then rupee increasingly depreciated year after year and there was an easy predictability about it. However, in the recent past and the present as well, since India is a rising economic story, the currency has a major and complex role to play.

It was learnt at a cost by many small and medium companies. The companies if India that bought cross-currency derivative products from banks last year are stuck with huge losses, and have sought the intervention of the courts and the RBI to bail them out. Since many currencies were rising against the dollar, including the Indian Rupee, the Indian companies took a contrarian call and bought cross-currency products which bet on a marginal dollar recovery. As many world currencies appreciated vis a vis the dollar, that did not happen. The exposure of small and medium size companies to these transactions is expected to be to the tune of up to $3 billion.

These companies or the private banks will have to provide for losses arising out of these exotic derivatives because these contracts are in the process of expiring. So there are many issues at stake.

Many companies blame that they were sold exotic products, when they entered in to such deals, by the private banks in violation of a circular from the RBI as it prohibits the sale of derivatives without a real underlying transaction. They say the RBI circular has the effect of law as per precedents set by judgments from higher courts. While this may be legally correct, it is also true these companies would have happily gone through with the deals if they had worked in their favour. They too have a responsibility for the mess.

Conflict of interest was also an issue there. Evidently banks were both advisors and sellers of the cross currency option. The two functions are clearly separated in more developed currency markets. The point is some of these problems would have been taken care of if a proper currency exchange under an independent regulator were functioning.

It has now been recognized by the RBI and it has written to the finance ministry for further consultation. An independent currency derivatives exchange with proper market makers, advisors and a strong regulator may go a long way in mitigating the current systemic failures.

The index is probably the only exception to all the usual derision and clichés that routinely accompany the combination of economics and statistics. This yardstick has become the lightening rod for capturing the entire range of emotions that stock markets are able to generate. But like all objects of adoration, the stock market index too needs constant care and high maintenance. That applies to the stock market indices in India too, which might need some re-engineering to stay ahead of the times.

The Indian market’s affair with a formal index began in 1986, when the Bombay Stock Exchange formulated its own gauge and called it the 30-share sensitive index. This index, puckishly nicknamed sensex, soon captured the imagination of a market.

Asia’s oldest market may have got its index later than usual, but adequately made up for the delay with its all-consuming pre-occupation with its new toy. Till then, the market had to make do with indexes constructed by other organisations. Somehow, it was believed that the exchange was better equipped to launch an index and maintain it on an on-going basis.

Since its launch, the sensex has been on a tumultuous journey. But, recent events seem to indicate that it may probably be time to reassess the current index and make some course corrections. The urgency seems to have got accentuated by the sharp increase in volatility witnessed during the past couple of months. Some of the fall-out from this instability is also reflecting on the IPO market.

What’s going wrong with the current avatar of the index? For starters, it seems to be sending wrong signals to the market. In other words, the sensex does not seem to be correctly reflecting the market mood, or capturing the core sentiment prevalent in the market. On many occasions, while the sensex has shown an upward movement, a closer look at the disaggregated figures reveals that the number of shares that have declined in the market is far greater than those that registered a gain during the day. Conversely, it has also happened that the advances outnumber the declines on days when the sensex has lost some ground.

For example, on February 18, the sensex lost 67 points. But, that was on the back of only 876 stocks losing value, compared to 1,848 stocks gaining in value the same day.

In other words, close to 68% of the stocks traded that day had gained in value and yet the sensex closed lower over the previous day’s closing value. It cuts both ways actually. Take the example of February 13, when the sensex gained 341 points. But, only 26% of the stocks traded that day showed any gains -712 stocks advanced versus 1,984 that declined. These are not isolated examples; this phenomenon is being repeated over many days.

In fact, this odd market behaviour can be witnessed in the movement of the Nifty as well, the National Stock Exchange’s 50share reply to BSE’s sensex. One would have expected the Nifty to exhibit greater stability since it has a higher number of stocks. Unfortunately, that’s not the case.

Let’s take one of the days mentioned above. On February 13, the Nifty also gained by 91.2 points. But, only 34.55% of the shares traded moved up - only 408 advances versus 773 declines. The Nifty shadows the sensex to a great extent.

Leap across continents and compare the behaviour of Dow Jones Industrial Average, which also has 30 shares. Data tracked shows that, on most days, when the Dow fell, the declines outnumbered the advances. Likewise, on days the Dow notched up gains, the number of advances was higher than the declines. There’s a straight, one-to-one correspondence between the index and the fate of all the stocks being traded on the exchange.

This is not the case in India. So, what’s with the Indian stock indices? One thing is dear: the individual stocks in the index are being manipulated, either to mislead investors deliberately or to offset punts in the sensex or Nifty futures. In reality, it is mostly the latter. The futures and options market today is in multiples of the cash market, resulting in the tail wagging the dog. This leads us to a larger point: the market is so shallow that only a few investors can manipulate a couple of stocks and impact the index outcome.

The end result is that a distorted index tends to send out wrong signals to many other market participants who are not involved in these machinations. Even though both the exchanges say that it is difficult to manipulate index stocks, there is some prima fade evidence to suggest that the securities market regulator needs to take a look at this before it spirals out of hand.

The government’s relentless attempts to whittle down the double-taxation treaty with Mauritius are causing uncertainty among foreign investors. Taxation of FIIs has been dogged by uncertainty for several years. This encompasses two elements. Most FIIs are registered in tax havens like Mauritius. They mostly declare their income as capital gains and pay no tax because of the tax avoidance treaty.

In the absence of the treaty, short-term capital gains would have attracted 10% tax. The concern expressed by the Indian tax authorities that investors from third countries are routing their investments through Mauritius is strange. Investors have located in Mauritius only to access the Indian market. A lightly regulated offshore tax haven can be a major boon to a continental sized economy with higher taxation rates, the Hong Kong-China combine being the classic example.

 Mauritius has played a similar role for India. The second complication has arisen in the context of a series of rulings by the Authority of Advanced Ruling (AAR). This relates to whether the income earned by FIIs is business income or capital gains. The AAR has ruled in some cases that income earned by FIIs is business income and in other cases capital gains. Though the legal landscape is unclear the worst possible outcome would be if FII income is held to be business income and they have a permanent establishment. This combination would mean they are subject to tax rates in the 30-40% range. That would make India uncompetitive compared to markets like Singapore, Hong Kong and Dubai, which do not tax capital gains. Singapore’s top income tax is 20%, Hong Kong’s lower.

The central government, in particular the CBDT and the finance ministry, needs to take a policy decision on FIIs. Our view has been that FII inflows have been good for the economy. They have increased corporate governance standards enormously. By helping create liquid capital markets they have helped foreign direct investment (FDI) by making entry and exit easier. Our recommendation would be to keep the tax regime as it is. Most FITs declare their income as capital tax and pay either 10% on short-term gains or none at all if there is a tax treaty. We feel that shouldn’t change.