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Why Indian investors are fretting over tax on equity gains, elections

Market crash and after: Rising bond yields, Fed rate hike fears give Wall Street the flu, Sensex sneezes.

Written by George Mathew , Sandeep Singh | Updated: February 7, 2018 9:45 am
A Chinese investor monitors stock prices at a brokerage house in Beijing, Tuesday, Feb. 6, 2018. Shares tumbled in Asia on Tuesday after a wild day for U.S. markets that resulted in the biggest drop in the Dow Jones industrial average in six and a half years. (AP Photo)

The runaway rally and scaling of new peaks by the Sensex on an almost daily basis until the presentation of the Budget on February 1 have been put to rest for now. Rising bond yields across the world, the possibility of higher inflation, and steeper interest rate hikes have dampened sentiment. The Sensex fell 561 points or 1.61% on Tuesday — it has now lost 2,087 points, or 5.75%, over the last six trading sessions. The markets opened 1,000 points lower on the back of weakness in the global markets — the Dow Jones Industrial had fallen 4.6% on Monday, and the Hang Seng in Hong Kong fell 5.1% on Tuesday. Nikkei in Japan and Shanghai Composite in China fell 4.7% and 3.4%. During the afternoon trading hours, major European indices were down by over 2%.

Read | Global crash has market tottering, Rs 2.7 lakh crore wiped out in a day

What led to the fall in the United States?

On February 2, the Dow Jones Index at the New York Stock Exchange fell 666 points after the US Labour Department reported that employment had risen more than expected in January, with the biggest wage gain in more than eight-and-a-half years. The picture of workers commanding higher salaries fuelled apprehensions of a rise in inflation, which could prompt the Federal Reserve to take a more aggressive approach to rate hikes this year. The US 10-year Treasury yield surged to 2.8450%, the highest since January 2014, which could make returns on Treasuries look more attractive relative to stocks.

On Monday, the Dow Jones plunged by 1,175 points, or 4.7% — its largest single-day point drop in history. With the US economy growing, expectations of inflation are going up — which means the Fed may raise interest rates faster, and the markets are worried that it may push investors to move to US Treasury bonds, and suck out liquidity from the equity markets. Last week, Janet Yellen, the former Fed Chair, expressed concern over high valuations in stock markets and real estate.

And what are the concerns in India?

On February 2, a day after the Budget slapped a 10% long-term capital gains tax on equity gains of over Rs 1 lakh, and projected a higher fiscal deficit, investors dumped stocks across the board, and the Sensex fell 840 points. Investors read the overshooting of the fiscal deficit target for the next fiscal and rising bond yields as deterioration in the government’s finances, raising the spectre of a spike in interest rates. Indian bond yields were also rising, raising fears of an increase in rates by RBI. The fall accelerated on Tuesday, as Wall Street plunged.

Market experts say that an accelerated pace of hike in interest rates in the US amidst concerns over inflation will lead to an outflow of foreign portfolio investor funds from emerging markets, including India. While the “hot money” (short-term money) of global hedge funds and arbitrage funds may be the first ones to move out, even medium-term money may go out from both debt and equity markets in India, to be parked in US Treasury bonds.

While continued inflow of retail money into Indian equities through MFs could act as a counterbalance to FPI outflows, market experts say that the imposition of the LTCG tax may disrupt that inflow of retail money — and new investors may no longer come as they have in the last three years. Some experts say retail investors are concerned about compliance issues around keeping track of days of investment, and calculation of capital gains for payment of tax.

So, what can be the impact?

One argument is the crash happened in the middle of an equity market rally and, therefore, a recovery is possible. When global markets crashed in 2007-08, the Dow fell 7% in its worst single-day hit. The Sensex, too, got a drubbing as the contagion spread to India. Indian markets picked up steam only from 2014. Now nobody is sure whether the equity markets have seen the bottom. If the bear hug continues, the biggest casualty will be investors who have recently entered the market. Domestic investors pumped in huge amounts through MF equity schemes, which witnessed an inflow of Rs 1,40,201 crore in 2017, and assets under management crossed Rs 22 lakh crore. Systematic Investment Plans (SIPs) showed a big jump. If the new investors suffer big losses, they are likely to keep away from the market for some time at least.

Foreign investors who pumped around Rs 2,00,000 crore into the debt and equity markets, will also exit. This will have ramifications on the current account deficit (CAD), as India has been managing the CAD through higher inflows. If CAD widens, it will lead to more complications for government finances.

Thirdly, the Initial Public Offering (IPO) market, which staged a major turnaround in 2017, will go for a toss. Hundreds of companies that have lined up IPOs will have to rework their plans. The disinvestment of public sector companies will also be hit. In the year gone by, a number of PSUs including GIC and New India Assurance had floated IPOs, raising thousands of crores for the government.

And of course, once sentiment is hit, it is not easy to get investors back into the market.

What is the outlook for the future?

While the LTCG tax will be seen as the starting point of the ongoing sell-off, experts point to a series of headwinds for the Indian markets over the next year. FPI movements will be critical, and markets will closely watch the results of state elections in Karnataka, Rajasthan and Madhya Pradesh. Several markets experts feel a Congress victory in Karnataka and blows to the BJP in Rajasthan and Madhya Pradesh may result in the markets not providing returns to investors this year. Markets are also apprehensive that if the central government sees hurdles on the road to the 2019 Lok Sabha elections, it may use Minimum Support Prices to pass on money to farmers.

The Stock markets made spectacular gains in 2017 and in January 2018. The runaway rally also raised fears of a bubble, and experts like Uday Kotak, Vice Chairman and MD of Kotak Mahindra Bank, cautioned against too much money going into some select stocks. The Sensex and Nifty had risen by 7,765.02 points (27.59%) and 2,300.50 points (26.39%) respectively since the 2017 Budget. In calendar 2017, the Sensex gained 7,430 points, or 27.90%, and investors made huge notional profits of Rs 45.50 lakh crore. In January 2018, the Sensex gained 1,908 points or 5.60%. However, experts had been cautioning that this year’s ride may not be as smooth and profitable as last year’s for the stock markets.

10,000-point rise since May 2014, with a few sharp falls

January 6, 2015: 854.86 pts
Concerns over global growth amidst continued decline in crude oil prices, and worries over Greece’s ability to remain a part of the Eurozone

March 9, 2015: 604.17 pts
Stronger than expected US jobs data and fear of rate hike by Federal Reserve

May 5, 2015: 722 pts
Cut in earning estimates of India Inc on the back of poor results and sell-off by Foreign Portfolio Investors

August 24, 2015: 1,624.51 pts
Weak manufacturing data in China pulls down market indices worldwide

January 7, 2016: 554.50 pts
China halted trading after 7% fall in its markets

February 11, 2016: 807.07 pts
Dow closed at a two-year low triggered by tumbling oil prices. On the domestic front, concerns grew around rising NPAs of banks

November 11, 2016: 698.86 pts
Demonetisation and crackdown on black money made markets nervous, as did Donald Trump’s victory in the US presidential election

February 2, 2018: 839.91 pts
Impact of imposition of LTCG tax on equity gains exceeding Rs 1 lakh; decline in US markets on concerns of inflation and the accelerated pace of increase in interest rates

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        1. Atish Bakshi
          Feb 7, 2018 at 12:58 pm
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