Budgets are anything but non-events for equity markets. Knowing that this was finance minister Arun Jaitley’s last full budget before the next general election, equity markets were optimistic. So much so, that the 30-stock S&P BSE Sensex hit a life high of 36,443.98 on January 29, within two minutes of the release of the Economic Survey for 2017-18. And despite the survey’s caution about elevated stock prices, the S&P BSE Sensex closed 232.81 (0.65%) higher on January 29.
Interestingly, Ved Malla, associate director, S&P BSE Indices, points out that this time was quite different. The volatility in the S&P BSE Sensex in the 30 days before the budget was relatively low compared with the run-up to Jaitley's previous budgets.
But equity markets are all about surprises. They didn't react to the initial budget announcements on rural development. But what spooked them was when Jaitley announced the long-term capital gains tax. Investors immediately hit the sell button without stopping to understand the full implications of the proposal.
The 30-stock index fell to a day’s low of 35,501.74 or 463.28 points lower than the 35,965.02 closing value of January 31. The Sensex was trading below the 35,965.02-mark for nearly 35 minutes after the budget speech before recovering to 36,250 levels, only to fall again below the previous day's close. And that went on for the final trading hour of the budget day.
While most market experts across business news channels in a knee-jerk reactions said that the LTCG was going to bring panic in the market, there were others who applauded the finance minister for his bold move. “It (LTCG) has achieved the purpose of creating a level playing field across investment asset classes, it will garner tax revenue for the government, curb malpractices and at the same time it seems non-disruptive,” says Motilal Oswal, chairman and managing director of Mumbai-headquartered Motilal Oswal Financial Services. “Non-disruptive because all gains until January 31, 2018 are protected."
Oswal saw the tax burden as a boon for mutual fund investors as the LTCG would reduce churn. “To avoid leakage of 10% tax and the resultant loss to compounding of gains, it is now necessary to avoid redemption and repurchase on a yearly basis in the name of ‘booking gains’ and ‘re-evaluating investment options’," Oswal says.
Similarly, Mumbai-based Rajeev Thakkar, chief investment officer of PPFAS Mutual Fund, argues that many a time the taxation of different asset classes drives investment decisions. He says that the LTCG on debt funds is 20% with indexation benefit. So, if a debt fund generates 8% returns in a scenario where inflation is 5%, the 20% LTCG would be levied on the 3% difference, which effectively works out to 0.6% , which is slightly lower than 10% of the returns. And this budget proposes a 10% LTCG on equity funds without indexation benefits. “In short, taxation ceases to be the critical factor in selecting asset classes,” says Thakkar. Like Oswal, Thakkar also believes that given the LTCG it would be best to keep portfolio churn to the minimum, irrespective of the types of mutual funds.
Mumbai-based Kalpen Parekh, president at DSP BlackRock Mutual Fund, calls the LTCG comeback after 13 years the most impactful budget provision. Like a true mutual fund advocate, Parekh argues that for investors looking to grow their capital over long periods of time, equities remain the most efficient asset class as it offers higher growth at still lower tax rates compared to other asset classes like fixed deposits, gold, and real estate.
And Parekh's argument is based on statistical evidence. "If we seek evidence on the impact of budget on future returns of stocks, the outcome is very random,” says Parekh. “In the last 21 years, since the budget day, the future one-year market returns have seen a very wide range of minus 47% to plus 102%. This is in line with the randomness of short-term returns and confirms no correlation between budgets and future market returns.”
He further points out that equity returns over time are driven by earnings growth and valuation rerating. “In the current environment, earnings growth momentum is picking up for good companies across many sectors while room for price to earning rerating is less as we are at elevated valuations,” says Parekh. “Hence, as investors we should increase the time horizon of our investments and LTCG introduction will indirectly encourage this trend."
Aashish Somaiyaa, managing director & CEO of Motilal Oswal Asset Management Company, does not see any impact of the LTCG as he too believes that investors have to make investing decisions on the basis of relative attractiveness. “We are pleasantly surprised with the nuanced and well-considered implementation (of LTCG).” Protecting all past gains until January 31, 2018 was the right way to implement the tax, he says. “Equities are for wealth creation and a 10% tax on the gains is not deterrent enough,” says Somaiyaa.
While the budget was expected to be populist, the LTCG was the prime reason for the market closing 58.36 points lower at 35,906.66. After all, as per returns filed for assessment year 2017-18, the total amount of exempted capital gains from listed shares and units is around Rs 3,67,000 crore. “Major part of this gain has accrued to corporates and LLPs (limited liability partnerships),” Jaitley said in his speech. The rest would now prefer to be long-term investors. After all, we all love tax-free investment options.