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India Cuts Tax on Overseas Borrowing to Lure Capital Flows

Finance Minister Palaniappan Chidambaram
Finance Minister Palaniappan Chidambaram is seeking to regain investor confidence and revive growth in Asia’s third-largest economy. Photographer: Graham Crouch/Bloomberg

India slashed taxes on overseas borrowings by local companies, stepping up a policy revamp to revive investment inflows. Stocks and the rupee climbed.

The so-called withholding tax, a levy on interest earned by overseas investors in foreign-currency bonds, loans issued by Indian companies was cut to 5 percent from 20 percent, the Finance Ministry said in a statement in New Delhi today. The reduction will be applicable for three years, effective July 1, according to the statement.

“Reduction in withholding tax will lower costs for companies, especially infrastructure borrowers, by up to two percentage points,” Jayesh Mehta, the Mumbai-based managing director at the Indian unit of Bank of America Corp., said in a phone interview. “The measure will encourage more borrowings abroad by Indian companies.”

Finance Minister Palaniappan Chidambaram is seeking to regain investor confidence and revive growth in Asia’s third-largest economy. Today’s measures follow government’s decision last week to increase diesel prices to reduce its subsidy burden and allow foreign investment in industries including retail, aviation and power exchanges.

The rupee strengthened 1.8 percent to 53.4063 per dollar as of 3:57 p.m. in Mumbai, while the BSE India Sensitive Index rose 2.2 percent, the biggest gain among Asian benchmark stock indexes. The yield on the 10-year bonds due June 2022 rose to 8.17 percent from 8.16 percent earlier.

‘Low-Cost Fund’

The government wants to lure foreign capital in order to bridge the current-account shortfall which widened to a record $21.8 billion in the three months ended March, fueling the slide in the currency. The rupee has gained 3.7 percent since Sept. 13, the day government announced an increase in fuel prices.

“It is to attract low-cost funds into India for investment,” Chidambaram told reporters at a news conference. “Funds are available at a very low cost overseas and interest rates are extremely low abroad.”

Former Finance Minister Pranab Mukherjee, in his budget speech on March 16 lowered the withholding tax for only infrastructure companies to 5 percent to help fund the construction of roads, ports and power plants. The latest proposal will be for all companies.

The government also today announced a plan which gives retail investors, with an annual income of less than 1 million rupees ($18,709), a tax rebate of 50 percent if they invest as much as 50,000 rupees in equities, according to the statement. The investment, which is permitted in mutual funds and exchange traded funds, will be locked-in for three years.

About 25 million Indian households invest directly or indirectly in the capital markets, according to a survey in July 2011 by the National Council of Applied Economic Research, compared with a population of over 1.2 billion.

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