FX loans to get cheaper as FM cuts withholding tax

The FM today cut the withholding tax from 20% to 5%. Hitherto this lower rate was only for infrastructure loans. This innocuous looking amendment may change the way Indian corporate borrow, reports CNBC-TV18’s Latha Venkatesh.

Reducing withholding tax from 20% to 5% is a very seminal change. This move will make most foreign loans cheaper by nearly 1% or maybe 75-100 basis points from where it is currently. A point may be argued that this is already available with Indian banks. Indian banks from their foreign branches could raise FX loans which were not charged withholding tax because these banks anyway pay an income tax in the country. Ultimately, it’s the foreign banks which gains the advantage. The reason why this is being registered all along is because it makes monetary policy non sense. Monetary policy is raised so that people don't loan too much and generate limited economic activity which in turn will create inflation. This reduces the power of monetary policy to cool down the system because FX loans could get cheaper at such a stage and reduce the impact of monetary policy.
This rule has been brought to reduce the current account deficit of the country by increased capital flows, but it is not a very healthy manner to reduce the current account deficit by increasing debt capital flows. Increasing equity capital flows, reducing imports or making Indian exports attractive are positive ways to bridge the deficit. The same route was used by Russia in the past with some disastrous results. But that’s the way we have decided to go and sense is that it is a single reason why the rupee appreciated today. We put it to probably RBI intervening but the big rally in the rupee happened because FX loans become cheaper from the day the notification comes.