Why it was an important budget for equities and mutual funds

The budget may not have been hugely positive for the equity markets and mutual funds in policy terms. The much-feared tax on LTCG did come through, albeit in a much toned-down manner. But it cannot be denied that this budget was significant for equities and equity funds from an investor’s perspective. Here is why

A boost for equities as an asset class

This may sound a tad ironical but this budget has given a macro thrust to equity as an asset class. By focusing on sustaining the benefits of demonetization, the government has continued its pressure on gold and realty as asset classes. That puts equity at an advantage. Also, the higher fiscal deficit is likely to be negative for bond yields, which have already been going up sharply in the last few weeks. With bond prices likely to be under further pressure, this is again a case for equities. That is the negative vote but look at the positive side. The massive allocations to rural spending and hard infrastructure are likely to have a multiplier effect on GDP growth. This is a lot more value-accretive for equities than for other asset classes. So at a macro level, equities really do not have reasons to complain.

LTCG finally comes back with a window

The good news is that LTCG is not a flat tax but only for profits above Rs.1 lakh per year. The bad news is that this tax will be imposed over and above STT and it comes without the benefit of indexation. So your profits at the end of 20 years will be 10% lower. That is the story in short! What is actually worrisome is that this has also been made applicable to equity funds and that is significant as equity funds are an important asset class for the large mass of investors to meet their financial planning goals. Yes, there is a window till March 31st this year when you can sell without incurring tax on LTCG. But that is more of a risk than a benefit from the market point of view. Ideally, this could have been avoided or could have been used to substitute STT.

Key implications for dividend funds and long-term bond funds…

If you rely on equity funds for wealth creation, you do depend on bond funds for stability, safety and regular income. Now you have a problem. In fact, you have two problems with the equity funds and the debt funds. Dividends paid out by equity funds will now attract dividend distribution tax (DDT) at 10%. That is double taxation because the company paying dividends has already paid tax on dividends in the first place. Also, this is likely to shift preference for growth plans over dividend plans to avoid the unnecessary additional 10% DDT. Also, your bond fund portfolio may have to undergo a shortening of the maturity profile to reduce your price risk.

Greater risk appetite for rural folks and senior citizens

This is a strange positive for markets. There is a huge safety net for rural India and scores of freebies. Also, farmer incomes are likely to be assured at 1.5 times the cost of production and rural livelihood gets an allocation of Rs.14.34 trillion. All this is likely to make rural India a serious part of the investment community with higher purchasing power and lower risk exposure. Senior citizens will now pay a lower tax on interest on bank deposits. The exemption limit has been increased from Rs.10,000 to Rs.50,000 and without the overhang of TDS. Look for an increase in risk appetite of senior citizens and it is perhaps time for brokers to start looking at senior citizens as a serious investment class for equity products.

Look out for a surge in quality paper via disinvestments

The aggressive divestment target of Rs.80,000 crore in 2018-19 is a mix of minority stake sales and strategic sales. So investors are going to see a lot of quality paper coming into the market. You will have a lot of listed companies increasing their floating stocks; you will also have a lot of unlisted PSUs being monetized through the stock market and there will be intermediary products like the CPSE ETF which will be a big opportunity for investors. The reason the infusion of quality paper is important is that it reduces the risk of asset inflation in the stock markets. When too much money chases limited quality paper, the result is higher P/E ratios. That is automatically toned down when the large-scale high-quality paper will come into the market.

It is hard to say whether the budget is positive or negative for the equity markets and for mutual funds. But it needs to be underscored that this budget is significant in more ways than one!

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