Budget 2016: Expectations for Debt and Commodity Investors…

Apart from equity markets, the debt markets also have certain expectations from budget 2016. The commodity markets are yet to deliver on their promise and this budget could be critical for giving them the much needed prop. The last budget took the momentous decision of merging the Forward Markets Commission into SEBI to bring about better and more focused regulation of financial markets. Here are a few key expectations from the Union Budget this year…

A clear direction on interest rates…

One can argue that rate cuts are a job of the Reserve Bank of India. However, the key parameters that the RBI considers before taking a rate cut decision are largely driven by the government of the day. Inflation trajectory is largely dependent on the government in terms of government spending, managing food prices etc. The budget needs to give a clear indication that inflation will be kept under control. The government needs to lay out a series of measures to control the sticky food inflation. Once food inflation is reined in with a clear plan, the impact of a higher fiscal deficit on inflation will be largely manageable. Debt markets and debt mutual funds will look towards clarity on the trajectory of interest rates. While the RBI will be driven by the data, it is for the government to provide an inflation trajectory through the Union Budget 2016.

A benign inflation target will be more conducive to debt markets as investors tend to prefer debt mutual funds at a time when interest rates are on their way down. For the benefit of debt as an asset class, the government trajectory of inflation will be very critical in this budget.

Why the anomaly on taxation of mutual funds…

Currently, equity mutual funds have a distinct advantage over debt mutual funds when it comes to taxation. For example the definition of short term capital gains is 1 year in case of equity mutual funds and 3 years in case of debt mutual funds. The bigger worry is that in case of debt mutual funds long term capital gains are also taxable. This creates a piquant disadvantage for debt funds because, on the one hand they have to be held for 3 years to qualify as long term gains and on the other hand they still have to pay long term capital gains tax.

To put debt funds on a comparable scale with equity funds, this budget can make a beginning by making long term capital gains on debt funds also exempt from tax. Of course, the government can choose to define 3 years as long term capital gains in case of debt funds. But having already put them at a disadvantage, debt funds should at least be permitted to enjoy exemption from long term capital gains. From a financial planning perspective, this makes the choice between equity and debt mutual funds a lot more seamless and agnostic.

Addressing the issue of Fund of Funds (FOFs)… 

Fund of Funds (FOF) is not a very popular instrument in the Indian context but an extremely popular product abroad. One of the reasons that FOFs have not taken off in India is due to the unfavourable tax treatment that they get. Let us understand! A Fund of Fund (FOF) is a mutual fund of mutual funds. An FOF is created by aggregating different mutual funds. Now if you create an FOF by combining different equity funds, then it should qualify as an equity fund for tax treatment purposes. But under the Indian tax laws, the FOF is treated as a debt fund for tax purposes even though they may predominantly invest in equity funds.

This anomaly needs to be removed if FOFs need to pick up as an asset class in India. What the Union Budget 2016 can clarify is that that if more than 51% of the funds held by the FOF are equity funds then it can be classified as an equity fund for tax purposes. This clarification will go a long way in building up interest in Fund of Funds (FOFs) in India.

A prop for commodity markets…

There were great expectations in the last Union Budget when the FMC was merged into SEBI. That trend can be underscored by the following points:

  • The Commodity Transaction Tax (CTT) was introduced 4 years ago on the lines of the STT on equities and derivatives. Its contribution to revenues is marginal and hence the CTT can be abolished to let the nascent commodity markets flower in the first place.
  • Government must use the budget document to underscore its seriousness about a seamless capital market by pushing for a rapid and logical conclusion to the NSEL issue, which is still pending resolution.
  • The idea of bringing commodities and equities under a single regulator was to create a seamless financial market encompassing equities, derivatives, commodities, currencies and debt. The government can take the first step towards that goal in Union Budget 2016.

For more news and updates on Union Budget 2016, visit Religare Online.

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