Curious anomaly in the Rajiv Gandhi Equity Scheme

Theres one measure in Budget that,if operationalised properly,could be revolutionary.

Even though theres nothing specific in the Union Budget 2012 about mutual funds,theres one measure that,if operationalised properly,could prove to be revolutionary. This is a new equity-based tax-rebate scheme that is designed to attract new retail investors into equity investments. The somewhat predictably-named Rajiv Gandhi Equity Scheme was introduced by the Finance Minister thus: To encourage flow of savings in financial instruments and improve the depth of domestic capital market,it is proposed to introduce a new scheme called Rajiv Gandhi Equity Savings Scheme. The scheme would allow for income tax deduction of 50 per cent to new retail investors,who invest up to R 50,000 directly in equities and whose annual income is below R 10 lakh. The scheme will have a lock-in period of 3 years.

This bland description holds several interesting innovations. Firstly,its after a long time that investors have a tax-saving option that is dedicated to equity investment alone. Section 80C,in contrast,is flexible as far as the asset class goes. Investors can choose to put the money in fixed-income avenues like PPF instead of ELSS equity funds,and indeed,most of them do so. In the new scheme,theres no optionif you want this additional tax rebate you have to invest in equity. Tax rebates are always the most important driver of investment behaviour so one can expect to the scheme to be popular.

However,based on what the minister said in his speech,there is a curious anomaly in this measure. I hope that when the details are announced,then equity mutual funds are part of the definition. Otherwise,to encourage inexperienced investors to buy stocks directly with a three-year lock-in could end up being a disastrous investment experience for the investors. Despite the great official passion for bringing the small,retail investor into the equity markets,direct investing in shares is the worst way to bring this about. The only way retail investors an safely and conveniently access the fruits of equity is to invest in equity mutual funds.

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This scheme could actually have an even larger significance for the stock markets at large. If structured correctly,it could well generate long-term equity inflows of a scale that could match up to FII inflows. Lets say that hypothetically,it eventually grows to a crore of investors investing R 50,000 every a year. Thats R 50,000 crore a year of reasonably long-term (well,at least medium-term) money. In eight out of the last ten years,that figure would have exceeded the net FII investment in Indian equities. It could be the most amazing boost for the Indian equity markets. And none of it would be hot money.

The equity scheme apart,out of the other measures in the budget,the move to exempt savings bank interest of up to R 10,000 from income tax is also more important than it sounds at first. Last year,the government had exempted those who had no income except a salary of up to R 5 lakh from filing tax returns. Unfortunately,few people were able to use it since everyone has at least some interest income from a savings bank account. The new measure fixes this.

Apart from the new equity scheme and the exemption of savings bank interest,there isnt anything else thats notable regarding personal finance. Of course,the new Direct Tax Code is now delayed yet again,hopefully by no more than a year.

This time,the recommendations of the standing committee have reached too late for the DTC to be implemented from April 1. Unfortunately,the finance minister didnt actually give a timeframe for its implementation,even though he has brought the tax rates and slabs to the level recommended by the DTC.

Author is,CEO,Value Research

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