Controlling market whims
Deploying the capital gains tax is the most sensible method to cool down overheated market
The imposition of long-term capital gains (LTCG) tax on gains from equity and mutual funds trading is possibly the most sensible thing that the government could do in its effort to contain the overheated Indian stock market. Taxes are rarely welcomed by those who are subjected to pay. Investments in equity have long enjoyed dividend tax exemption. That policy was sensible and benefited millions of long-term investors in equity, who want to be a part of a listed company by holding its ordinary shares. However, when market speculators in equities turn a bunch of high stake gamblers, there are reasons to worry for both the market regulators and the government.
The pre-budget economic survey clearly expressed the government's serious concerns over highly elevated levels in India's stock markets. The stock market is generally regarded as a barometer of a country's economic health. The Narendra Modi government, seriously trying to promote its 'Make-in-India' campaign, would have been very happy if the stock market boom truly reflected the industry's financial health and bottom lines of listed companies. In contrast, the stock market surge had coincided with a growth downturn of the Indian economy in 2017. On the contrary, the stock surge in some of the other countries, including the US, has been in keeping with their economic growth acceleration.
The real-life story of industry in India is different. Scores of large companies are suddenly faced with insolvency and bankruptcy proceedings. Although the automobile, electronics goods and a few other sectors are doing well, they don't represent the general trend of performance of a majority of the industry. According to the latest India Ratings report, corporate loans worth around Rs two trillion can potentially turn bad in the next 12-18 months, though the overall additions to the non-performing loans category are seen trending downwards. Indian banks are already under the burden of gross NPAs to the tune of Rs 10 lakh crore. The RBI too in its Financial Stability Report said that its stress test of the banking sector showed that NPAs may still rise. However, the stress in the banking sector "while significant, appears to be bottoming out," it said.
Unfortunately, the stock market boom, especially through 2017, did not reflect these concerns. The government's Chief Economic Advisor Arvind Subramanian could not ignore the fact that the Indian stock market's rise in the last two fiscals had outperformed several major markets across the world. Since end-December 2015, the S&P index surged 45 per cent, while the Sensex surged 46 per cent in rupee terms and 52 per cent in dollar terms. The country's current corporate earnings to the GDP ratio has been sliding since the Global Financial Crisis, falling to just 3.5 per cent, now. Conversely, corporate profits in the US have remained a healthy 9 per cent of the GDP. Newly legislated tax cuts in the US promises even higher post-tax earnings of its companies. However, it must be noted that ever since the BJP-led NDA government came to power, the market expectations of earnings growth started building up. Lower inflation and lending rate cuts by the RBI and the banks further stimulated the highly positive market sentiment. In fact, it was these expectations that lie at the origin of the stock market boom. Unfortunately, speculators in the market pushed this sentiment too far. The result was a near-continuous boom belying the market reality and corporate financial performance. Such market behaviour is unhealthy for investors, the market and the economy as it lends a wrong projection of the on-ground performance of the industry.
In effect, Finance Minister Arun Jaitley had done the right thing to impose an LTGC tax of 10 per cent on stock market gains exceeding Rs one lakh. Significantly, Bombay Stock Exchange chief Ashish Kumar Chauhan gave his 'silent consent' to the Finance Minister's proposal and felt the impetus to the International Financial Services Centre (IFSC), gold exchanges, disinvestment, ETFs for debt financing and measures to revive corporate bond markets augured well for the capital markets. Hopefully, the LTCG tax will stabilise the market at least to some extent as market bullies may still make a rampaging return depending upon how the actual economy performs in 2018.
The Finance Minister has strongly defended the action and said very clearly that the government was not considering the abolition of the security transaction tax (STT), following the re-introduction of long-term capital gains tax on equities and equity-linked mutual fund schemes. Even if the government wanted to tap a small portion of high profits being reaped by speculators and not by the industry or real economy, there is absolutely no harm. It is unbelievable that the long-term capital gains out of share trading last year amounted to Rs 3,67,000 crore. The LTCG tax target in the next fiscal is around Rs 20,000 crore.
The government could have imposed a higher rate of LTCG tax on speculators making a windfall in the stock market when the real economy was battling the impact of demonetisation and GST to maintain its growth. "There was a time when LTCG was not imposed because we wanted to get money into the stock markets," Jaitley said replying to the discussion on the Budget in the Lok Sabha. "That is no longer the situation. We did an assessment and found that the exempted income from Long-Term Capital Gains last year amounted to Rs 3,67,000 crore." Together, it is a huge sum. The beneficiaries were hardly small investors. Mostly large corporates, high net-worth individuals, foreign institutional investors and limited liability partnership (LLP) firms made the killing. For them, it was so easy to make big money while industry, in general, was trying to recover from the low growth, bankruptcy shocks.
(The views expressed are strictly personal)