The Free Ride is Over

The free ride is over for the capital markets. The long-term capital gains (LTCG), proposed in the union budget by finance minister Arun Jaitley, may not affect the large-cap stocks much, but mid-cap stocks will definitely be hit, at least in the short term.

At present, sale of equity shares and equity-oriented mutual funds on which securities transaction tax (STT) has been charged are exempt from tax. This means that any gains from sale of equity shares or mutual funds held for more than a year are not subject to any kind of tax whatsoever. Not anymore. Jaitley proposed to re-introduce the long-term capital gains tax on gains arising from the transfer of listed equity shares exceeding Rs 1 lakh, at 10%, without allowing any indexation benefit. However, all gains up to January 31, 2018 will be grandfathered.

As a result, I fear the mid-cap stocks are likely to lose their lustre in the country’s capital markets. Traders and brokers are likely to focus on large-cap stocks now. The profits from mid-cap stocks, which constituted a substantial portion, are now likely to be taken off the books of investors and portfolio managers.

Meanwhile, the short-term capital gains tax at 15% will continue for transfer of shares within 12 months.  Short-term capital gains (STCG) from the sale of equity shares or equity-oriented mutual funds on which STT is charged is taxed at 15.45% (including education cess), instead of the normal slab rates.

The extension of reduced corporate tax rate of 25% to companies which have reported turnover of up to Rs 250 crore in financial year 2017-18, is a welcome move for SMEs and MSMEs, yet the loss of revenues for the government will be a meagre Rs 7,000 crore. The government had reduced the corporate tax to 25% from 30% in the Union Budget of 2017-18 for companies with a turnover of Rs 50 crore in the financial year 2016-17.

While I admire the finance minister for targeting the fiscal deficit at 3.3% of the GDP, it might be a tad ambitious. One will need to study the finer print to understand how such a target can be achieved, but prima facie, it is a highly ambitious target, given the state of infrastructure.

From the country’s economic point of view, there are a few positive takeaways from the budget. The focus on healthcare is great, both as a social initiative and in developing the healthcare infrastructure. The promised spend on developing urban and rural roads and smart cities will be sure to galvanise the economy, particularly the digital infrastructure. The attention the finance minister has paid to the rural sector augurs well for seed and agriculture-focused companies.

I do fear that bond investors might be slightly jittery. They might have drawn some relief from a lower than expected borrowing programme. But this relief could be short-lived. Big bond investors such as India's state-owned banks could be hit as yields go even higher than the 96 basis points they climbed in the past six months—the most in Asia. The 10-year benchmark yield is already hovering around 7.55%.

The key factor to watch out, for me, would be the government’s adherence to fiscal discipline. To sum up, on a scale of 1 to 10, I would rate this pre-election year union budget at around 7.

(The author is the chief executive officer of Avendus Capital Public Markets Alternate Strategies )

(The views expressed in this article are not those of Fortune India)