This week is the 30th anniversary of an important threshold in our nation’s economic evolution. On August 20, 1994, India’s acceptance of IMF’s Article 8 obligations was the culmination of the initial set of landmark reforms in liberalising our external payments from the erstwhile days of rationing foreign currency and irrationally pegged exchange rates administered by Kafkaesque discretion.
It may be recalled that in the aftermath of the BoP crisis in 1991, India had to be bailed out by IMF. But, by 1994, we were confident in our liberal and markets-based forex management to such an extent that we formally accepted full convertibility of the rupee for the current account of the balance of payments. Section 2a of Article 8 prohibits members from imposing ‘restrictions on the making of payments and transfers for current international transactions’. There are exceptions that allow for specific considerations:
- Transitional arrangements to facilitate graduation out of existing exchange strictures.
- Historical bilateral agreements.
- Exchange controls for security reasons, including counterterrorism and anti-money laundering.
- For curbing monetary instability.
Acceptance of Article 8 obligations is not about gaining cosmetic international approbation. The allocative efficiency of the Indian external payments system was enhanced, and it was an important signal of the confidence in our capacity to manage a liberal exchange regime. It further galvanised investors’ confidence that India is serious about an open balance of payments and was committed, in due course, to full capital account convertibility – a basic precursor to the internationalisation of the rupee on an appreciable scale that Indian policymakers, befitting a G5 economy, mention. There is no doubt that our commitment to liberal external payments has been a contributory factor why, during difficult times over the last three decades, our access to global capital has been relatively unhindered; this encompassed the Asian financial crisis in 1997, sanctions for the nuclear tests in 1998, the global financial crisis in 2008, the ‘taper tantrum’ in 2013, the actual taper in 2018 and the Covid outbreak in 2020.Recently, we have made it costly for resident Indians to repatriate money abroad with the introduction of a transfer tax (IMF’s terminology). In October 2020, TCS was introduced on remittances of more than ₹7 lakh under LRS; the tax rates of 0.5-5% were modest. In 2023, for categories other than education and health, TCS was hiked to 20%, which is not modest by any yardstick. While the I-T law provides for the reimbursement of the tax by claiming credit, the measure is an exchange restriction since it is an additional burden on making current international payments and transfers. It is unclear whether this vicarious tax is a forex measure dressed up as a fiscal measure or vice versa.The backdrop is a rise in remittances post-Covid, a durable spike in outward FDI and a precipitous drop in inward FDI. If the objective of the tax is to reduce outbound remittances, then it betrays a scarcity economy mindset of the past (pre-1994); that is, we are short of forex and, hence, it must, in some form, be conserved to manage the exchange rate. Restrictions inevitably engender discretion and delays that embolden a form of moral suasion to emerge within the administrative and banking system that increases explicit financial costs (that are transparent), and non-transparent informal costs for citizens who avail of LRS. There has been talk of ‘rationing’ within LRS sub-categories, presumably for gift, maintenance for relatives abroad and investment. The additional burden is real as no interest rate is paid by the gov on the withheld tax amount, which given the lag in the filing and processing of taxes can take up to 16-18 months; undoubtedly, the time value of money is significant.
If the goal is only to mitigate tax evasion by ‘catching’ those who remit their untaxed income, then it behoves on the gov to pay a full compensatory rate of interest on the tax that is withheld. Collateral consequences of policy modification entail changes in incentives of economic actors regarding policy stability, credibility of rules and overall expectations about the future. In private, shrewd stakeholders, not unreasonably, wonder if the transfer tax on remittances could herald future intermittent changes in our external payments’ architecture. Therefore, the gov must figure out whether the transfer tax is the best deterrent against tax evasion, leaving aside that evaders are much more likely to use the ‘hawala’ route rather than formal channels like authorised dealers. The tax, presumably unwittingly, has engendered distortion in the forex market; a ‘dual exchange rate’ is encouraged because, inevitably, the curb market in the rupee gets a fillip. It has also undermined faith, to an extent, in the unfettered two-way movement of foreign currency in the current account.
In conclusion, it cannot be the case that evaded income is only used for purchasing foreign currency. So, should the remit of TCS be expanded to include other sizeable domestic purchases? One sincerely hopes not. Even for tracking information, TCS is superfluous because of the annual information returns regime that is in place. TCS on remittances under LRS has no economic virtue worth the name, hence we must get rid of it.