India's move to target tax evaders through a general anti-avoidance rule (GAAR), along with a plan to retroactively tax the indirect transfer of assets, has spooked investors and added to an exodus of funds, battering the rupee.

Starting on Monday, India's parliament will begin considering the finance bill that includes the tax proposals but final details may be a month or more away, government sources have said, which could prolong the uncertainty and aggravate a balance of payments shortfall.

"We are hoping that because of the currency and because of inflow problems, they might either delay it by a year or do something else," said Samir Arora, an India-focused fund manager with Helios Capital Management in Singapore.

After days of what traders said was intervention to defend the rupee, the Reserve Bank of India late on Friday took steps to encourage dollar inflows, a move dealers said may do little to improve near-term weakness in the currency, which is approaching an all-time low set in December.

Meanwhile, the gloomy mood derailed the year's biggest initial public offering from India, with auto parts maker Samvardhana Motherson Finance Ltd on Friday scrapping its $311 million issue because of poor demand.

Foreign funds are usually the biggest buyers of large Indian equity deals.

Adding to investor ire, India said on Friday it may review its tax break treaty with Mauritius, the East African island country that the majority of foreign portfolio inflows are believed to be routed through.

Mauritius is the same source of fund flows India is targeting through its GAAR proposal.

"Govt going all out to make foreign investors flee India. GAAR is not yet settled and they are making statements on Mauritius treaty review," tweeted Sandip Sabharwal, head of portfolio management services at Prabhudas Lilladher Group.

BATTERED SENTIMENT

The GAAR proposal and a move that would tax already-completed mergers of foreign companies with Indian assets, potentially putting Britain's Vodafone (VOD.L) back on the hook for more than $2 billion in taxes even after India's Supreme Court ruled in its favor, have slammed investor sentiment.

Already, investors had been put off by policy paralysis following a spate of corruption scandals as well as slowing growth, persistent inflation and a fiscal deficit that ballooned to 5.9 percent of gross domestic product in the last fiscal year as the government has been politically unable to cut fuel subsidies.

Macquarie's (MQG.AX) $1.5 billion Asian Alpha Fund exited its short positions in Indian single stock futures in response to the proposed tax rules, instead using a futures contract in Singapore to get its short exposure to India.

The hedge fund also cut its India long exposure in March, joining a number of foreign investors reducing holdings in the country ahead of the expected tax rules.

"The Indian government has been making many, many big policy mistakes," Mark Mobius, executive chairman of Templeton Emerging Markets Group and one of the best-known emerging markets investors, told Reuters on May 1.

The rupee is down about 9 percent since the beginning of March, closing at 53.47/48 to the dollar on Friday, putting it close to a record low of 54.30. During March and April, net portfolio outflows from India stood at about $540 million, compared with $13 billion in inflows in January-February.

Outflows are painful for a country that imports 80 percent of its oil and has a widening trade gap. Exports rose 21 percent to $303.7 billion for the fiscal year that ended in March, while imports rose 32.2 percent to $488.6 billion.

Late last month, Standard & Poor's cut the outlook for India's credit rating to negative, putting Asia's third-largest economy in danger of losing its investment grade status. It said India had reserves to meet about six months of current account payments, down from eight months in 2008 and 2009.

GAAR

Investors worry that GAAR will give authorities broad latitude to determine tax liability and they want clarity on how it will be enforced. Some expect implementation to be delayed given India's habit of postponing policy initiatives.

A Finance Ministry official who declined to be identified told Reuters there was no plan to defer GAAR. Government sources have also said the tax would not be applied retroactively.

In the meantime, some offshore investors have been routing investments to India through Singapore instead of Mauritius.

GAAR is intended to close a loophole that allows foreign investors to avoid capital gains tax on short-term investments by routing them through tax havens.

Tax authorities could impose a short-term capital gains tax of 15 percent on foreign institutional investors (FIIs) if they are proven to have registered in countries with tax exemptions just to avoid paying Indian taxes.

The government has not explained what criteria will be used to determine what qualifies as an impermissible arrangement, prompting investors to complain that it is too vague.

"There's no clarification at the moment, and uncertainty obviously affects the market," said Taina Erajuuri, who manages the FIM India fund from Helsinki.

(Additional reporting by Manoj Kumar in NEW DELHI and Nishant Kumar in HONG KONG; Editing by Robert Birsel)

• A Permanent Economic Emergency