Redrawn tax treaty credit negative for Mauritius: Moody's

India getting its tax treaty redrawn with Mauritius is a credit negative for the Island nation as it will now be a less attractive platform for investing in India, Moody's said today.
Although Mauritius will lose a historical advantage, it does not lose a competitive advantage because the other key financial centre for investment in India, Singapore, will also be subject to similar capital gain changes.
India on May 10 signed an amendment to its three-decade old Double Tax Avoidance Agreement (DTAA) with Mauritius to remove a longstanding advantage that allowed investors to avoid paying capital gain taxes in India by channelling their investment through Mauritius.

"The taxation agreement is credit negative for Mauritius because its financial centre will be a less attractive platform for investing in India than it used to be," Moody's said in its Credit Outlook report.
A curtailment of new investment flows through Mauritius would cause a deterioration in its balance of payments equal to 1-2 per cent of GDP annually, and consequently put pressure on its foreign exchange reserves.
"However, a sharper shift in investor sentiment would have more dire consequences," it said.

Mauritius' financial industry is the primary source of net financial inflows from abroad. It contributed 10 per cent of GDP in 2015 and substantial financial net inflows over the past five years allowed foreign-exchange reserves to double to USD 4 billion between 2010 and 2016.

"The tax changes will weaken its balance of payments, consequently increasing its external susceptibility," it said.
Companies using the DTAA operate in Mauritius under a Global Business Company-1 (GBC1) licence are subject to Mauritian tax jurisdiction, and benefit from an advantageous tax regime, including low corporate taxes and nil capital gain tax.
At the 2014-end, Mauritian companies with GBC1 licences held USD 200 billion in Indian assets, according to the Financial Sector Commission of Mauritius, constituting 38 per cent of their USD 520 billion total assets held worldwide, including in Mauritius.
These assets are invested abroad and in countries that have DTAAs with Mauritius.

For firms utilising internationally focused financial centres such as Mauritius, the traditional business model is mainly to channel funds with limited effect on host country.
"For Mauritius, the funds involved are so large relative to the national scale that they affect the country's balance of payments and banking sector," Moody's said.
"However, the reform effort to date has not yet achieved
the conditions that would support an upgrade to Baa2, in particular in accelerating private investment to support high, stable growth, without which the government's debt burden -- a key constraint on the rating -- is likely to remain high for a sustained period," it said.

Moody's, which had raised India's outlook to positive from stable, said the asset quality, loan loss coverage and capital ratio of banks remain weak and this poses sovereign credit risks.
"While recognition of non-performing loans has largely been achieved, lack of resolution of impaired loans will continue to constrain India's sovereign credit profile until a viable resolution mechanism is put in place," it said.
Moody's further said India's rating is constrained by low per capita income, over dependence of farm sector on monsoon and high government debt.
On the revenue side, India's large low-income population limits the government's tax revenue base. At 20.9 per cent of GDP in 2015, general government revenues were markedly lower than the 27.1 per cent median for Baa-rated sovereigns.

Although the implementation of GST and other measures that are aimed at enhancing tax collection will help widen and boost revenues, the effect will only materialise over time and their magnitude is uncertain so far.
"As a result, the general government deficits will remain sizeable and any reduction in India's government debt burden will largely rely on robust nominal GDP growth. We expect that the debt-to-GDP ratio will hover around the current levels, at 68.6 per cent in 2015, before falling gradually as nominal GDP growth is sustained and revenue-broadening and expenditure efficiency-enhancing measures take effect," it said.
Moody's said it will consider a rating upgrade on evidence that institutional strengthening will elicit sustained macro-economic stability, higher levels of investment and more favourable fiscal dynamics.

Evidence of institutional effectiveness will get reflected through revival in private investment, improving infrastructure, and/or additional policies to enhance India's economic and financial strength.
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India's core credit strengths are its size and growth potential, which are among the highest of Moody's-rated sovereigns and provide key support to its 'Baa3' rating.
"Low incomes constrain India's sovereign credit profile by limiting the government's revenue base and adding to its social and development spending requirements," it said.
In an environment of lacklustre global trade which we expect to continue, India's very large domestic markets provide a relative competitive advantage compared to other, smaller and more trade-reliant economies.

As the economy shifts towards higher value-added and higher productivity growth, incomes will continue to rise faster than in most other economies. Combined with the very large size of the economy which prevents high concentration and hence vulnerability to sector-specific shocks, higher incomes will bolster economic resilience.
India's significantly reduced and now very low external vulnerability also contributes to resilience by sheltering the economy from abrupt changes in financing conditions.
Moody's, however, cautioned that it could revise India's rating outlook to stable if economic, fiscal and institutional strengthening appeared unlikely, or banking system metrics remained weak or balance of payments risks rose.

Moody's said the decision to maintain a positive outlook on the Baa3 rating rather than assigning a stable outlook was driven by economic and institutional reforms that continue to offer a reasonable expectation that India's growth will outperform that of its peers over the medium term and expectations that further improvements in its macro-economic and institutional profile will be achieved.