ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Deductibility of Interest Cost, Retention-of Profits and Development-of Stock Market-A Comment

Deductibility of Interest Cost, Retention of Profits and Development of Stock Market A Comment L M Bhole A CONSIDERABLE degree of deve- lopment of the financial system has occurred in India during the post- independence period. In the course of this financial development, investors have increasingly preferred to hold secondary (indirect) rather than primary (direct) securities. This has been naturally reflected in the pattern of financing of different deficit-spending units, particularly the corporate sector which happens to be one of the major deficit sectors in the economy. While its dependence on borrowed capital has steadily increased, the contribution of the stock market to its financing has been subsidiary. Sometimes an unwarranted concern has been exhibited in certain quarters about these developments and different people have come out with conflicting policy suggestions which, if implemented, would supposedly lead to the development of 'active', 'healthy', and 'effective' stock markets, and to the evolution of the right balance in the capital structure of the companies. A case has been made for lowering of interest rates to channelise investible funds to the stock market It has been argued that the average return on shares has remained lower than the return on bank deposits, therefore interest rates on bank deposits should be reduced. It has been further argued that this would lead to reduction in interest rates on public deposits with companies and to the boosting of the investment market.1 We have elsewhere discussed in detail as to how such a policy is ill-advised and how the correct measure to discourage the growth of public deposits with companies is to raise interest rates on bank deposits rather than to reduce them,2 That the authorities had to reverse the cheap money policy both the times (in 1968 and 1978) within a short period after its adoption itself indicates the untenability of the case for low interest rates in India, Recently two other policy measures have been suggested to activise the stock market in two articles which have appeared in this journal.3 In contrast to Parekh's view, Patil has argued for higher cost of debt capital to achieve the same purpose. However, Patil would like to raise the cost of debt capital not by increasing interest rates but by removing the deductibility of interest cost clause In our tax laws. Chitale has opposed Patil's suggestion and has recommended that companies should be discouraged from retaining profits if the current yield on equities is to be made attractive. The purpose of this note is to show that Patil's suggestion has no valid

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