The Prime Minister’s speech at the inauguration of the NISM campus outside Mumbai on 23rd Dec, 2016 seemed to have spooked certain players in Dalal Street, enough to have triggered a 0.9% drop in the Sensex, thus dragging it to a 7 month low. Although, the Finance Minister has gone on record since then to dispel further selling off and attributed the reaction to a minor misinterpretation, the Prime Minister’s speech itself comprised of other elements, besides, which demand worthy attention.
Far from advocation of textbook neoliberalism, the rarity of the domestic bond and capital markets in the funding of infrastructure was spoken about, the importance of regulating unfettered markets were highlighted and also the need for merging technological development with agriculture was mentioned.
More specifically, the underdevelopment of the domestic capital market warrants further attention. It was mentioned by the Prime Minister himself that most of the infrastructure funding in India stemmed from the government or from banks. In order for capital markets to contribute significantly, funds would need to be locked in for a long period, something that FIIs would normally be averse to. Such a requirement mimics a regulation that the previous RBI Governor, Dr. Raghuram Rajan had imposed on 5thFebruary, 2015, where he stated that FPIs investing in debt instruments would have to lock them in for a minimum of 3 years.
The need for imposing a restriction on the lock in period for investments is clear. Yet, the implementation is more challenging since such a limitation in exercise might have a tendency to simmer down bullish sentiment and the policy might end up being counterproductive. In this light, it would seem to be more prudent to use price policies instead of quantitative restrictions.
The Tobin Tax, first proposed by American economist James Tobin in the 1970s seems to be an useful mechanism to achieve this goal. The original Tax suggested by James Tobin was a tax on all spot conversions of currencies.
The idea behind the tax was to discourage substantial speculative behaviour. Thus, according to Tobin, if an international consensus could be reached wherein each country was to levy a certain tax that would discourage volatile capital inflows, economies would be far less susceptible to fickle investor sentiment.
Revenue generation is not however, a primary objective behind the Tobin Tax. This structure as an instrument was also proposed back in February 2015 by prominent academicians as a feasible method for discouraging high volatility of foreign inflows. Moreover, in his book, Global Crisis Recession and Uneven Recovery, the erstwhile RBI Governor, Dr. Y. V. Reddy lays specific stress on the Tobin Tax and how it might be conducive to the Indian Scenario.
Since its inception, the definition of the tax has been subject to no minor degree of distortion owing to the fact that several countries have imposed levies which have been categorised under the ambit of Tobin Tax. And yet, the experience has been ambiguous at best. Thailand, Colombia and Chile have not produced any substantial results. The result is also not clearly positive for Brazil and Sweden. Malaysia stands as the only country where the desired results were obtained and that too owing to the substantial stress that its public policy had put on the implementation of the same.
It would thus seem that the feedback for this policy would depend largely on the endogenous conditions prevailing at an economy at a certain period. Thus, although the ideal behind the policy is in tandem with requirements that the Prime Minister mentioned, the feasibility still remains a large blockade.
In his book Dr. Reddy mentions that although the Tobin Tax has not garnered much success historically, there is little scope for such a policy to be toxic in the long run. Moreover, he finds that an economy which has imposed an almost benign tax structure in its STT framework ought to work towards putting into execution a structure that levies a substantially high tax rate on short term capital gains than in the long term. Holders of Participatory Notes ought to be kept on a position that is in parity with other investors such that they are not given undue advantage. This would also provide substantial scope for preventing round -tripping of money through tax havens and generation of new black money.
It has been widely held by academicians and policymakers now that excessive financialisation of an economy would bring with it systemic risks and this might have considerable impacts on the economy as a whole.
In this light, in order to avoid the “tail wagging the dog”, levying of a neo-Tobin Tax on certain segments of the financial sector may do more good than harm. Such a measure could go a long way in bringing sound, long term capital into the economy, thus broadening the horizon for an underdeveloped bond market and hence, ensuring further pervasion of the same into key sectors.