emerging markets: political risk in India

the home field advantage

No company ever goes into a foreign country expecting a level playing field.  There are always going to be rules–written and unwritten–that favor the home team.  This is the flip side of the belief that you’re always going to have at least a slight advantage over a foreign company in your domestic market.

One exception–if you’re hoping that the foreigner will buy your domestic business.  Chances are he’d be willing to pay over the odds.  But it’s equally likely the government will force a sale to a domestic competitor.  Around the world, that’s just the way it is.

in sports

We see this all the time in sports.

Olympic judging.

Your favorite baseball team plays an away game.  You can be sure the field will be manicured to minimize the home team’s weaknesses and your strengths. The visitor’s dugout in San Francisco is, unusually, on the first-base side of the field?  Why?  It faces right into the frigid wind off the bay.

The home town timekeeper will make the game clock in basketball or hockey run fast or slow, as the home team requires.

Even the referees will exhibit a home-town bias, perhaps influenced by crowd noise.

what’s not cricket

Some actions are beyond the pale, however.  One such appears to be happening right now in India.

In 2004, when Vodafone was still intent on ruling the world, it entered the Indian cellphone market by buying an interest in an existing player from Hutchison Whampoa.  Aware that if the transaction were done in India it would trigger a capital gains tax of around $2.9 billion, the parties did the deal offshore.

The Indian Tax Department ruled that the tax was still due.  Vodafone refused to pay and lengthy litigation ensued.

Two months ago, the Indian Supreme Court ruled in Vodafone’s favor–that no tax was due.

proposed retroactive tax law change

On Saturday, the Financial Times reported that in its annual budget the Indian government proposes to change the tax law, retroactive to April 1962, to make offshore transactions involving multinationals and Indian subsidiaries subject to domestic capital gains tax.

Although the proposed change, if implemented, will have much wider implications than for Vodafone alone, it is being widely seen as aimed directly at the UK telecoms company.

The issue of course, is that Vodafone has played on the home field and won–but the losing side is trying to change the basic ground rules five years after the fact, in a way that turns victory into defeat.

I think it’s ironic that this situation is arising just as the Indian government has decided to try to woo foreign portfolio investors for the first time.  If the budget documents are not just bluster and parliament makes the retroactive tax law change, that would seem to me to dim substantially the appeal to foreign investors of India’s large domestic population.  The negative effect could last for many years.  For emerging markets investors, then, I think the Vodafone situation bears close watching.



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