On Episode 838 of The Core Report, financial journalist Govindraj Ethiraj talks to Ketan Dalal, Tax Expert and Founder of Katalyst Advisors.

SHOW NOTES

(00:00) The Take

(05:09) Will markets start adjusting to a war normal this week?

(09:12) India crude supplies are under control, though gas is still not

(10:37) Why did India and Mauritius sign a treaty allowing tax free investments and what’s changed now?

(21:50) Guess where rich Chinese are headed next

—

NOTE: This transcript contains the host's monologue and includes interview transcripts by a machine. Human eyes have gone through the script but there might still be errors in some of the text, so please refer to the audio in case you need to clarify any part. If you want to get in touch regarding any feedback, you can drop us a message on feedback@thecore.in.

Good morning. It's Monday, the 6th of April and this is Govindraj Ethiraj broadcasting and streaming weekdays from Mumbai, India's financial capital.

The Take

Six weeks into a war started by the United States and Israel that has violently disrupted global energy markets. India is experiencing a curious economic phenomenon.

Supply shortages, notably of gas, accompanied by virtually no serious price impact for everyday consumers. Now, politicians could view this as a triumph of state management, but the economic reality is a little more punishing. While the government has selectively raised prices on higher-octane petrol, jet fuel, and commercial gas cylinders, the broader consumer market for oil and gas still remains quite shielded.

The standard 14.2-kilogramme cooking gas cylinder for domestic use saw a modest hike of 60 rupees in the first week of March and has stayed there since. Commercial 19-kilogramme cylinders have seen two hikes, 115 rupees on March 1st and around 195 rupees last week. But by all analysts' accounts, prices everywhere, particularly petrol and diesel, still remain suppressed.

Now, with crude oil firmly above $100 a barrel and likely to stay there for the foreseeable future as the US and Israel get set for a full-ground war with Iran, the Indian government is trapped in a bind. Because when you try and fight the laws of supply and demand by capping prices, the invariable result is shortages. And those shortages are already hitting the most vulnerable.

Echoing the dark days of the COVID-19 pandemic, several migrant workers in major cities like Mumbai and Delhi, amongst others, are packing up and returning to their villages. They're not going because fuel is too expensive, but because they simply can't find it. Recent reporting by the Indian Express, which interviewed over 100 migrant labourers at Mumbai's bustling railway stations, paints a grim picture.

Close to half of them, primarily bound for Uttar Pradesh, Bihar, and West Bengal, cited the LPG crisis as their reason for leaving. Incidentally, most of these labourers have never been able to access the standard 14.2 kilogramme cylinders because they lack the Know Your Customer or KYC documents required for a registered connection. That's another problem for another day.

Instead, they rely on the popular Chotu 5 kilogramme cylinders, which require only a valid ID. On Sunday, the government's daily briefing note on the Iran war reiterated that these 5 kilogramme cylinders were widely available at local distributorships. But it's quite likely the reality on the ground is different, mostly thanks to the cornering and diversion of these cylinders into the black market, mostly for commercial use.

Hundreds of thousands of homes and businesses have meanwhile switched to kerosene, firewood, or electricity. Demand and supply are beginning to adjust, but not through calibrated public policy. Instead, the price signals are being dictated by the black market rather than the open market.

Because official prices are suppressed, the natural disincentives to cut consumption or shift to alternate fuels do not quite exist. Now, this is a precarious situation for an aspirational developing economy. India's upward mobility translates pretty directly into energy consumption, more two-wheelers, more air conditioners, more refrigerators, and more travel.

But it is quite clear that these aspirations must be calibrated or recalibrated to this new geopolitical reality, even if not of our making. And even if the US and Israel halt their bombing campaigns, or Iran ceases to respond by firing missiles across the Persian Gulf, normalcy is far away. So this is a world that's fundamentally changed.

Countries like India, which import close to 90% of their crude, have little choice but to lower their energy footprint. Remember, even if we have the crude, as we do, it's the price that matters. And prices, as we know, are ruling well above a $100 barrel, and likely to for some time.

One effective tool for demand destruction and resource allocation is the price that consumers pay. Moreover, if India wants citizens to tighten their belts, it could complement these price hikes with consistent public service messaging and visible austerity at the top. For instance, the example that came to mind is a reduction of the several dozen car ministerial convoys to maybe just two or three cars as one example, not for the fuel it saves, but for the message it could convey.

And I'm sure there are many other examples. Adjusting to this new energy normal will be tough. The good news is that demand moderation and supply matching are already underway, driven by extensive solar investments, electric vehicle purchases, and most recently, even a government-backed shift to induction stoves.

But all these transitions require time, or most of them do. In the interim, India must stop hiding the true cost of global energy prices from its citizens. Hiking prices is the only way to signal a willingness to adapt.

India must prepare to pay the real price of a changed world.

And that brings us to our top stories and themes…

Will markets start adjusting to a war normal this week?

India's crude supplies are under control, the gas is still not.

Why did India and Mauritius sign a treaty allowing tax-free investments, and what's changed now?

Guess where rich Chinese are headed next?

Markets, War, Oil, and The Rupee

Top aides to US President Donald Trump in recent days have said that Iran's power-generating facilities and bridges are legitimate military targets because destroying them could cripple the country's missile and nuclear programmes. According to officials who spoke to the Wall Street Journal, Trump confirmed as much on Sunday morning by a Truth Social post, even saying that Tuesday was the day that he had set for comprehensive bombing. So the next step, it would appear, is the direct targeting of civilians.

The way this could be done is that civilians would be given warnings of a few hours to vacate their homes that they've lived in all their lives, and then entire blocks could be pulverised with aerial bombing. Or that may not happen either, which means no warnings and the US will go for direct bombing and carry through the publicly announced pledge by the US President of bombing Iran back to the Stone Age. What this means is that oil prices will remain high or climb further, and stocks will dip again this week.

On Friday, Brent futures were about close to $8 higher at $109 a barrel, and US West Texas Intermediate futures were at about $111 a barrel, which was their highest absolute price rise since 2020, according to a Reuters report. Both benchmarks remained below highs near $120 a barrel, which were touched earlier in the war. So we have no holidays in the bank, so to speak, this week or for coming weeks, so be prepared for a head-spinning roller coaster week ahead.

Last week, though, ended well, at least in the positive. The Sensex staged a 2.5% recovery or almost 1,774 points on Thursday to close up 185 points to 73,320. And despite the rebound, the market was 0.4% lower.

The Nifty 50 was up 33 points to 22,713, but down 0.5% for the week. Overall, this marked the sixth consecutive weekly decline for both indices, their longest losing streak since October 25, according to a Reuters report. Now the silver lining in all of this, if one were to look for one, is that the markets are beginning the process of adjusting to a long war and focussing on the impact points, which of course is to do with energy and crude supplies.

If crude supplies continue to be managed effectively, as India is doing with some demand moderation and price corrections, we could be entering a more steady market phase with a return to focus on domestic fundamentals, including companies specific. There will, of course, be issues of interest rates and inflation to deal with, but we could come to that a little later. The one downside to this calculation is that foreign portfolio investors are still selling heavily.

After pulling out about $12 billion in March, the first few days of April have apparently seen almost $3 billion of fresh sales. Some analysts believe the multiples are adjusting quite rapidly and the tide should turn even for FIIs. It might, but may not be soon.

Though, for now, a slowdown in selling, particularly by FIIs, will help more than buying. The rupee jumped on Thursday after the Reserve Bank of India tightened the screws on speculative bets against the currency and the rupee had its best day since 2013, when policymakers also resorted to extraordinary measures to stabilise markets, according to Reuters, which added that the rupee rallied to a peak of Rs. 92.83 and closed at Rs.

93.10, up 1.8% for the day.

—

The trade war and the real war are both nudging the government to open up the economy further. The government abolished import taxes on petrochemicals used for making plastics and pharmaceutical goods after it invoked emergency powers and diverted local chemicals for production of cooking gas because of shortages caused by the war, according to Reuters.

The import tax on 40 products is valid till June 30, the government said. Analysts told Reuters the government's decision to grant customs duty exemption on select petrochemical products appears to be aimed at easing cost pressures across downstream industries and providing relief to end consumers.

Iranian Oil is Back

By all accounts, the throughput of traffic through the state of Hormuz appears to be rising.

Indian refiners have purchased Iranian oil, India's oil ministry said on Saturday. India, which is the world's third biggest oil importer and consumer, had not received a cargo from Tehran since May 2019, following U.S. pressure not to buy Iranian crude. The oil ministry said that amidst the supply disruptions, Indian refiners have secured their crude oil requirements, including from Iran, and there is no payment hurdle for Iranian crude oil imports, according to the Reuters report, which added the government saying India imports crude oil from 40-plus countries, something they've said in the past, with companies having full flexibility to source oil from different sources and geographies based on commercial considerations.

A Bloomberg report also quoted the oil ministry denying payment hurdles for impeding these purchases, and the statement is a rare public recognition of energy ties that India largely abandoned as a result of U.S. sanctions, but has begun to rekindle thanks to the current conflict and a subsequent United States government waiver allowing purchases of Iranian crude on sea, according to that Bloomberg report. The government statement also said that it confirmed the arrival of an Iranian liquefied petroleum gas or LPG vessel carrying about 44,000 tonnes, which is presently discharging in Mangalore port.

Relief from Retroactive Taxation

Last week, the finance ministry said it won't apply anti-tax avoidance laws to investments made before April 1, 2017.

Now, that removes a major doubt in the minds of legacy private equity and venture investments in the country, and buyout firms sitting on billions of dollars of legacy assets in India had got some relief, thanks to that, according to a Bloomberg report. Now, all of this follows a court order in a Tiger Global case which raised fears of retrospective scrutiny. A landmark Supreme Court ruling in December said Tiger Global must pay taxes on its $1.6 billion sale of a stake in an Indian company in 2018.

The judges said Tiger Global used its Mauritius units that were only conduits and no benefit under an international treaty for pre-2017 investments would apply. This obviously caused concerns amongst investors who felt that Indian tax officials could reopen past transactions related to investments made before 2017, especially those routed via tax havens like Mauritius. I reached out to Ketan Dalal, tax expert and founder of Catalyst Advisors in Mumbai, and I began by asking him to describe where we were at this point on the issue of taxing foreign investments, particularly via havens like Mauritius, and the more interesting background to these Mauritius investments.

INTERVIEW TRANSCRIPT

Ketan Dalal: Let me just step back and let's just look at the larger picture and the factual construct of what has happened. From the pure factual construct, Tiger Global invested in Flipkart between 2011 to 2015, that is before 2017. Now, when Walmart was in the process of acquiring Flipkart, some of the existing investors including Tiger Global sold out.

This was in 2018 and it claimed capital gain exemption because see what had happened is Tiger Global had invested in Flipkart through Mauritius incorporated entities and because there was an exemption under the India-Mauritius tax treaty capital gain article 13 in technical terms, it claimed the exemption and it obviously didn't pay taxes. That is the factual construct.

Govindraj Ethiraj: So everything seems to hinge around this 2017 April cutoff period. So why is that important in terms of what happened before and what has come after?

Ketan Dalal: Yeah, so in order to understand the importance of the 2017 issue going, let's just step back. What had happened was that the India-Mauritius capital gain exemption was primarily in order to attract FIIs to invest. The FII regime or what is now called FPI but then FII was legislated in 1992 and there was already a capital gain exemption in the India-Mauritius treaty but that was not very relevant because foreign investments were very restricted up to that point of time.

When the FII regime was legislated, the India-Mauritius capital gain exemption suddenly started looking more relevant and Mauritius then legislated something called MOBA, Mauritius Offshore Business Activities Act under which it said we won't tax anything in Mauritius because the exemption said we will tax in Mauritius and not in India. So Mauritius said okay we also will not tax. At that point in time, the treaty came alive so to speak and FII started coming in through Mauritius which is the capital gain exemption clause.

However, there was some ambiguity and some doubt in people's minds so the government then came up with a circular in the year 2013, April 2000 if I remember rightly which said look the tax residency certificate that the Mauritius authorities will issue is proof of residence and therefore proof that you can claim the capital gain exemption. There was honestly going no talk of any substance or anything because to my mind this was a case of blessed tax avoidance in the sense that the government was completely aware and was willing to do this on the basis of the tax residency certificate but what happened was the policy sort of construct did not translate on the ground and the controversy kept cropping up.

Govindraj Ethiraj: And the reason we talk about this today is and when you use the word substance so what that means is essentially that it was never the case that there were real functioning enterprises in Mauritius and everyone knew that and understood that including the government of India but the latest supreme court judgement seems to question the fact that there is or there was any substance to start with.

Ketan Dalal: Yeah so what happened was that after the 2000 circular there was a 2003 supreme court judgement in the case of Azadi Bacha Vandoran where the supreme court once again reiterated the criticality of the tax residency certificate and essentially held in favour of the SSE but as I said unfortunately this keeps coming up again and again and ultimately the government in any case felt that now we have enough investments, we have enough incentives, it's an attractive country.

I'm not sure I agree with all of that but that was their view and be that as it may in August of 2016 it started a process of saying look both for Mauritius and Singapore we want to have a cutoff of 1st April 2017 and the meaning of that cutoff date is investments made after 1st April 2017 will not get the benefit of the exemption which obviously means that the government wanted to give the exemption for those who had invested before 31st on or before 31st March 2017.

So that is the actual answer to your question what is the relevance of this so the point is Govind investments made through Mauritius or Singapore on the basis of tax residency but let's stick with Mauritius particularly were supposed to be quote unquote grandfathered and capital gain exemption should have been available to it.

Govindraj Ethiraj: Okay so if we come to the present the latest concern obviously rose from the fact that the supreme court judgement came and people felt that other transactions could also be opened up for which this clarification came and you're saying of course this clarification is not saying anything new because that 1st April 2017 deadline was always known.

Ketan Dalal: Absolutely see what happened was let's step back and look at the tiger global judgement as I said the tiger global judgement factual position was that the investments were made before 2017. To be honest I don't think the government should have gone into litigation on that in the first place but what is happening is something is said at the top and the people who are at the operating level may not very very unfortunately look at it like that and what happened happened the supreme court went into oh did tiger global have substance or not in Mauritius etc etc and quite surprisingly they did not to my mind put enough emphasis on the fact that the TRC was enough the government had said it Azadi Bachao their own previous bench had said it the circular was very clear and the very fact that the amendment was made in relation to investments made after 1st April 2017 was obviously that investments made before were grandfathered to my mind should have been no controversy at all it is as simple as that actually but they held what they held you know.

Govindraj Ethiraj: Right so now to come to the present this judgement has obviously created some unease amongst investors I'm assuming portfolio as well as direct so where do we stand today and what needs to be done if so to give some comfort to investors that something from the past will not be pulled up once again.

Ketan Dalal: So there are two three parts to this you one is the government unfortunately late but at least as they can say better late than never realised the enormous damage that this has caused and they have amended the general anti-avoidance rules GAR on the basis of which the tiger global supreme court judgement was rendered and said look in the sort of clash between giving that exemption and grandfathering on the one hand and GAR on the other hand the grandfathering will take precedence over GAR which is obviously what was intended and we will we now hereby clarify so to speak that if it is grandfathered and before for 31st before 1st April 2017 it stands sheltered and not exposed to any capital gain tax in relation to the India Mauritius treaty this is what they have said this means that at least the level of unease will now hopefully go down substantially because it is now legislated now what happened to tiger global is a different issue altogether whether tiger global will go in a review petition etc which I suppose they will and I think that judgement honestly to my mind should be reversed and what's the wider implication and what can we do to address that see what has happened go in this to me this sort of and to international investors more it looks like a retrospective amendment it's a judgement it's not an amendment but you know they'll say oh the government said that investment that I made before 1st April 2017 are grandfathered and now the supreme court says this so what is the sanctity of that government's promise is it not reneging on a promise if I was an international investor this is what I would think and I think this is what they have thought you already have had FIIs pull out I'm not saying it is because of tiger global judgement only but is it a contributor and has it played its stellar role in part of that pull up I would definitely think yes because see what has happened the credibility is impacted when you have a situation like that the the impression you are saying is I mean what is the sanctity of of an amendment what is the sanctity of this grandfathering what does it all mean there so I think that is the wider implication

Govindraj Ethiraj: Right and last question and to put it simply what's the moral of this story?

Ketan Dalal: See the moral of this story is that we cannot have double speak the government has to decide what was the priority the priority was getting exchanged they gave it an exemption they should have made it absolutely clear and what happened is that after that circular whenever there was litigation they should have pulled up the tax officer and said hold on we have already issued this circular what is the litigation about they should nip it in the bud and kill it unfortunately that was not done and the wound was allowed to fester and fester and then you had gangrene and you had to amputate the leg at least after this tiger global at least and as I said thank god for small mercies they seem to have realised I think a huge damage has been done part of that damage has been reversed but to specifically answer your question nip these issues in the bud do not let time go by too much because that is what sort of adds to the uncertainty and puts off investors.

Govindraj Ethiraj: Right Ketan bhai, thank you so much for joining me.

Ketan Dalal: Thank you.

The Chinese in Zimbabwe

Rich Chinese are buying houses in Harare, the capital of Zimbabwe, where upmarket residences now cost between half a million to two million dollars in the city's prime neighbourhoods, a Bloomberg report says. According to that report, following in the footsteps of British colonialists in the 19th century, the Chinese today are drawn to Zimbabwe's mineral wealth. In recent years, Chinese companies have come to dominate Zimbabwe's lithium extraction industry, which supplies about 10% of global demand, and have invested in steel mills and chrome mines.

Their arrival in Zimbabwe, says the report, echoes a broader pattern across much of the developing world, but with one notable difference. Whereas many Chinese migrants elsewhere have been relatively poor labourers, those in Zimbabwe are often wealthy. Now, this is partly because Zimbabwe has high literacy established, even though rundown industries and well-trained workforce, leaving little need for a lower skilled imported labour, according to that Bloomberg report.

And Zimbabwe's push to boost earnings from natural resources has also drawn more Chinese migrants into well-paid jobs running mines. Interestingly, in the 1970s, China had backed Robert Mugabe's Liberation Army as it fought for independence against Rhodesia's white only government. Leaders of the independence movement underwent military training in China along Maoist lines, while Mugabe as president championed a so-called look-east policy that favoured China over Western nations.

And now, says the Bloomberg report, the Chinese have also built and repaired state power plants, taken stakes in local banks, and invested in farming. Even Zimbabwe's new parliament building was built by Chinese developers.