Budget Review by Alok Singh, CIO – BOI AXA – Investment Managers

Will Long Term Capital Gain Tax derail the Great Indian Equity Story

Long Term Capital Gain Tax (LTCG) is not new to the Indian market, but last time when it was removed from equity related gains, the Securities Transaction Tax (STT) was introduced with the objective of better tax compliance. So, to be fair, the Government should have changed the STT structure along with the introduction of LTCG. But apparently, the equity market has become a victim to its own success

However, this doesn’t mean that with the introduction of LTCG, Indian equity has suddenly become unattractive for a long term investor. Indian equity market has generated a CAGR of over 15% in the last 20 years, which is higher than any other asset class even if we adjust it from tax. There is no reason to believe that Indian equity market will not be able to maintain a healthy CAGR going forward. Specially, when global economic growth is coming back and the Indian Economy itself is pegged to grow over 7% with reasonable amount of inflation. The ongoing result season so far has been much encouraging than previous few quarters and earnings growth seems to be returning to the equity markets. These along with the structural reforms taken by the Government so far should allow markets to remain positive

Despite LTCG, the Individual Investor participation into the equity market through mutual fund will not be dying soon. The reason is absence of any other investment avenue which is expected to do as well and also is as liquid as this asset class. Though we are focusing on the local issues we should also not forget that the Indian Equity market also had a lot of momentum coming from positivity in the global market and we don’t expect that to be fading soon.

I think this motivated the finance ministry to try and raise some additional revenue by imposing LTCG on the equity related gains. Finally we all should also acknowledge that the long term investment decisions have to be based on the return profile of the asset class over the period of time and not solely on the tax arbitrage.

The present NDA government has been trying to deglamorize the Union Budget since the beginning of their tenor. They have been trying to keep most of major policy initiatives outside the budget speech. But as they say, “Old habits die hard” – so, today was no different. However, the Union Budget is always looked at with great expectations on various issues. The Finance minister was clearly seen struggling between political compulsions and the fiscal prudence to maintain a finance balance. Though the pressure of 9 forth coming assembly elections and then the General Elections over the next 14 months forced him to sacrifice fiscal prudence and focus on rural/agricultural economy, which actually has been struggling for some time, at the same time it’s also true that the Indian agricultural sector does need a lot of bold structural reform to become sustainable and for which only few budget announcements like guaranteeing that the Minimum Support Price (MSP) for all kharif crops will be set at 1.5 times the cost incurred by the farmers are not sufficient.

The good part of the budget was that the Government continued with its capex. The Government Capex is budgeted to grow in FY19 at 10% comparable to the FY18 figure of -4%. In absolute terms, the Government capex will amount to Rs. 3 lac crores as compared to Rs. 2.7 lac crore in FY18 revised estimates.

The financial markets seem to be quite disappointed with the budget; the bond market was disappointed with the fact that the fiscal deficit is much higher than market estimates. Though the fiscal deficit as a percentage of GDP is expected to be 3.3% for the next year, which is lower than 3.5% for this year, the absolute amount of bond to be issued by the Government will be higher than the last year. The Government’s bias towards elongating the maturity profile of the Government debt means that this increased amount of bonds will most likely be long dated. In the current environment global yields are rising and RBI is concerned about inflation. The bond market is not ready to handed supply side pressures. The bond yields have already risen over 100bps in last 6months and may continue to remain elevated.

The Equity market which has been the morning star of India’s great growth story got a bit of hiccup in form of reintroduction of long term capital gains tax (CGT) at the rate of 10%, without any change to the Securities Transaction Tax (STT). This may impact some of the trading activity in the markets but from the long term investor’s point of view equity remains an attractive asset class. This belief becomes sanguine if you look at it in the light of recent quarterly results announced by various listed corporates.

Finally to be fair to the Government, in the present economic circumstances and the election pressures, the Finance Minister has delivered a budget which promises to support the economic recovery, and at the same time does not push the economy on the path of fiscal imprudence as we have seen in the pre-election budgets of the past. I also strongly believe that the Indian Juggernaut will continue to roll forwards and this budget will soon be forgotten by the financial markets.