Budget fine print drags markets down

The benchmark Indices, the S&P BSE Sensex and the National Stock Exchange’s Nifty50, witnessed their biggest intra-day fall in four years, as the equity markets tanked on the first full day of trading after finance minister Nirmala Sitharaman presented her maiden Union Budget on Friday.

While the Sensex had shed over 390 points, at Friday’s close on Friday, the 30-stock S&P BSE Sensex closed 793 points lower on Monday at 38,720.57 points—a collective fall of over 1,187 points over two trading days after the Budget. The fall was over 907 points in a single day if Monday’s low of 38,605.48 points was compared to Friday’s close of 39,513.39 points. The Nifty50, meanwhile, closed more than 250 points lower at 11,558.60 points; it shed 287 points in a single day if Monday’s low of 11,523.3 points was compared to Friday’s close of 11,811.15 points.

The fall was not restricted to the blue chips alone; the S&P BSE MidCap and SmallCap also tanked by 293 points (-1.99%) and 347 points (-2.46%) each.

Market experts blamed the Budget’s fine print for the decline. Mumbai-based Amar Ambani, president and research head at YES Securities, said the fall was on account of concerns over future fund flows into the secondary market and the detection of another fraud at the Punjab National Bank.

The Budget had also proposed a hike in surcharge on individuals with taxable income of ₹2 crore to ₹5 crore and ₹5 crore and above. Consequently, the effective tax rates for these two categories would increase by around 3 % and 7 %, respectively. “Hike in surcharge in the Budget will have an adverse impact on high-end consumption, as well as reduce the investible surplus of high-income individuals, whose money was the mainstay of mutual funds, portfolio management schemes (PMSs) and the midcap segment,” Ambani said.

He said that the increased surcharge also had a bearing on foreign portfolio investors (FPIs) coming in through the Trust route and taxation of category-3 Alternate Investment Funds (AIFs). “This potentially reduces the post-tax attractiveness of India, vis-à-vis other markets, where such a high rate doesn’t exist.”

According to Umesh Mehta, head of research at Mumbai-based Samco Securities, Monday’s fall was the worst single-day fall in four years. Mehta attributed a host of factors for the bloodbath, including FPIs’ reluctance since the past two weeks to commit to Indian markets. This, in his view, was a signal that the markets would correct. Also, the Street was also disappointed by the fact that the Budget did not have any direct fiscal or monetary incentive to jump-start the economy.

The other big blow came in the form of Sitharaman spelling out that it was the right time to increase minimum public shareholding in listed companies. The finance minister mentioned she had asked markets regulator, the Securities and Exchange Board of India (SEBI), to consider raising the current threshold of 25% to 35%. “Fears around squeeze in secondary market liquidity is also due to proposed higher public shareholding norms,” Ambani said.

The other cause for worry on the Street was buybacks. “In order to discourage the practice of avoiding dividend distribution tax through buy back of shares by listed companies, it is proposed to provide that listed companies shall also be liable to pay additional tax at 20% in case of buy back of share, as is the case currently for unlisted companies,” the finance minister had said in her speech.

That, in the Street’s view, was anything but positive. According to primary market data collated by Delhi-based PRIME Database, the markets have seen a total of 516 buyback issues between 1999 to 2019 (till June) which were meant to offer exit to equities worth ₹1,93,991 crore and actually acquired ₹1,59,896 crore. In fact, a sizeable ₹1,36,475 crore worth of buybacks were executed between 2015 and June 2019, through 208 issues.

According to a research note from Mumbai-based JM Financial Institutional Securities, the proposed additional tax of 20% on buybacks could lower effective (dividend + buyback) yields on the large-cap information technology (IT) stocks by up to 50 basis points (100 basis points make a per cent). “A normalisation in yield erosion could drive close to 10% downside from current levels, especially for stocks where a buyback was impending,” the note mentions.

Bu, while the dividend is tax-free in the hands of shareholders – except for large holders (with dividend income over ₹10 lakh) who have to pay 10% tax on dividend receipt above ₹10 lakh – buybacks lead to an incidental long-term capital gains tax at the rate of 10% in the hands of shareholders. For shareholders tendering their shares in buy backs, there is a breather because under the proposed structure after the applicability of the buy-back tax, the shareholders will be not be required to pay any tax on income arising from the buy-back, the note adds.

But, while the dividend is tax-free in the hands of shareholders—except for large holders (with dividend income of more than ₹10 lakh) who have to pay 10% tax on the amount above ₹10 lakh—buybacks lead to an incidental long-term capital gains tax at 10% for shareholders. For shareholders tendering their shares in buybacks, there is a breather because under the proposed structure, after the applicability of the buyback tax, the shareholders will be not be required to pay any tax on income arising from the buyback, the note adds.

A mix of negative news flows, along with no immediate measure being announced in the Budget to kick-start consumption and related economic activities, hit the equity markets, according to Pradeep Kesavan, senior vice president who oversees equity strategy for institutional equities at Mumbai-based Elara Capital. The negative news included a cut in Maruti’s vehicle production, a deficit in monsoons and reduction in area sown for kharif crops in an environment of continuing farm distress and weak demand for consumer products. “With valuations not particularly cheap any more, all these factors weighed heavily on the market and precipitated a fall,” Kesavan said.