As Budget 2018 is about to be announced on February 01st 2018, what are the key expectations of equity investors and mutual fund investors? Here are 10 such expectations that have been built around equities and mutual funds.
- The budget is expected to give a big push for rural spending and for consumption as they are the two likely triggers for growth. Since both these triggers have larger positive implications for equity markets there is a strong expectation that the government will focus heavily on rural infrastructure, rural employment schemes and rural spending.
- On the consumption front, the budget is expected to put more money into the hands of the people. Thus there are likely to be tax exemptions and rebates for the lower and middle income groups. These will be instrumental in boosting consumption and benefiting sectors like FMCG, consumer durables, two-wheelers, entry level cars etc.
- The budget is likely to sell returns as a function of risk and that means a greater focus on driving investors towards equity. The Economic Survey has already spoken at length on the need to translate savings into investments. One can look forward to lowering of rates of return on small savings and partial withdrawal of tax rebates. Both are likely to indirectly benefit equities.
- The Budget is likely to provide some additional sops to equity and equity funds as an asset class. For example, the Section 80C may be expanded to carve out a separate niche for ELSS. Under this section, infrastructure equity may also be included to give a boost to capital markets.
- The benefits of Section 54EC is expected to be extended to mutual funds and infrastructure stocks too, albeit with an appropriate lock-in. Currently, only bonds issued by institutions like the NHAI, REC, and IRFC are eligible for Section 54EC benefits. This list may be expanded to include infrastructure equity and infrastructure funds too.
- One of the major worries in the budget appears to be the reintroduction of long term capital gains tax. We do not see that happening for 3 reasons. Firstly, the government is committed to developing the equity cult in India. Secondly, the introduction of LTCG tax will mean scrapping of STT. Every year STT gives assured revenues of Rs.8500 crore to the government. They certainly will not want to miss out on that. There is also a talk of the LTCG time frame being extended from 1 year to 3 years. While that is possible, the practical problem will be in write-offs and carry forward of losses. Another anomaly will be that the ELSS with additional benefits will now have to be extending its lock-in to 5 years, which looks very unlikely.
- We see some clarity coming for the fund of funds (FOFs). Currently, FOFs are taxed as non-equity funds. The anomaly is that even fund of equity funds are taxed as non-equity funds. That means, they are treated as short term gains if held for less than 3 years and even long term gains are taxed at 20% after considering indexation. FOFs are important because in other countries they are a very important tool for financial planning. To encourage diversification of risk through FOFs, the government may look at putting them at par with normal equity funds at least for tax purposes.
- Equity as an asset class will be very keen that the fiscal deficit spillage is kept under check. The government touched 112% of the fiscal deficit in the first 8 months and it is likely to end the year with about 0.50% spillage in the fiscal deficit. That would be still acceptable but the markets will be keen to see a gradual tapering of the fiscal deficit back to the old targets of below 3%. In the last two budgets, the reason the markets really outperformed other asset classes was that the government had focused on fiscal discipline. Fiscal deficit guidance will be the key.
- No budget discussion on capital markets is complete without the discussion on FPI flows into India. In the last 1 year, FPI flows have been just about half of the flows coming from domestic mutual funds. While there are concerns on valuations which are outside the purview of the budget, the government needs to give the FPIs comfort that there will be no retrospective taxation. The budget can take a step by amicably closing out the pending legal cases pertaining to Vodafone and Cairn.
- The government has already emphasized that there could be higher taxes on the higher income groups while the middle income groups would be spared. So we could see the scrapping of the dividend distribution tax (DDT). At the same time, the 10% tax on dividends above Rs.1 million per year may either be enhanced or split into progressive slabs based on annual dividends received. The markets may not react too negatively to these announcements, although the scrapping of DDT will be positive.
On top of all these factors, there is the big game changer in the form of the corporate tax rate cut from 30% to 25%. It is not too certain whether the government will attempt such a measure in a year when resources are already crunched. But if it happens then it could really be a game changer for the equity markets. For tax rate cuts to be really positive for markets, they must come without the total withdrawal of exemptions. That is the catch!