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India budget could kill equity investment

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India budget could kill equity investment

India’s move to re-introduce the capital gains tax on equity investments is being seen as a populist measure ahead of the 2019 general elections.

In the latest annual budget announcement, finance minister Arun Jaitley said profits exceeding INR 100,000 ($1,553) from shares held for over a year will be taxed at 10%, without accounting for inflation indexation.

Shumita Deveshwar, director of India research at TS Lombard said while it is a dampener on sentiment, the move is also being seen as the government trying to increase as much tax revenue as it can before the elections.

In fact, investors were expecting the government to rescind the current securities transaction tax, she told Citywire Asia.

Since the budget was announced, India’s benchmark S&P BSE Sensex index, currently trading at 34,716 suffered two days of losses – and Nomura analysts expect market valuations to be capped.

The proposal also introduced a 10% dividend distribution tax on equity-focused mutual funds. However, gains for both taxes will be a grandfathered up to 31 January, 2018.

‘The budget is very much like that. [The government is] saying that we need to increase spending, we need to do things for farmers and low-income groups and we are going to get the money from those who pay taxes,’ Deveshwar said.

Since 2005, equities have been enjoying a tax advantage relative to fixed income and real estate in India to encourage long-term investors.

The efforts seem to have paid off, but outsized returns from India’s stock market in 2017, driven by domestic inflows, meant that the government was missing out on a significant chunk of revenue.

In view of grandfathering, Jaitley said the change in capital gain tax will bring marginal revenue gain of about [INR] 20,000 crores ($3.1 billion) in the first year, and the revenues in subsequent years may be more.

He estimated the total amount of exempted capital gains from listed shares and units to be around INR 3,67,000 crores ($57.1 billion) for tax returns filed during 2017 to 2018.

The new source of revenue is even more significant given certain government reforms – particularly the introduction of the new goods and service tax and demonetisation of the INR 500 and 1000 notes – haven’t had the desired effects.

‘The government is a bit lost right now. They are looking a bit frantic in terms that policies haven’t played out in the way they thought,’ Deveshwar added.

Moreover, the expert expects macroeconomic fundamentals, especially fiscal deficit, current account deficit and inflation, to deteriorate over the next 12 months.

‘So with all these macroeconomics headwinds, and as we go deeper into the political cycle, there is definitely going to be volatility. India is going to see a bumpy ride ahead,’ she said.

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