Capital markets players have great expectations from the Union Budget 2017. It needs to be remembered that this will be the penultimate Union Budget of this government as the 2019 budget will most likely be a Vote-on-Account. Typically, we have seen governments in the past adopt a populist tilt around the penultimate budget. What form this populism takes is hard to predict at this point of time. But we do have a broad outline. Firstly, the thrust will be on rural spending and rural infrastructure. This will not only improve rural purchasing power but also act as an antidote against the pain that rural India had to go through during the demonetization exercise. Secondly, the budget will come down heavily on black money and the capital markets could be one of the targets the government will be looking at. Lastly, the government will look to bring about an alignment between the tax structures of equity and other investment instruments.
On the basis of this broad theme, we have 10 broad expectations from the Union Budget as far as the capital markets are concerned…
- We expect the budget to give a boost to consumption demand. This will include rural and urban demand. This will be used as a method of partially compensating for the troubles caused by demonetization. If the government goes ahead aggressively on this front, then it could have a salutary impact on stocks that are driven by rural growth and consumption demand. In fact, the consumption story, which was put on hold due to demonetization, may return with a vengeance.
- The real estate sector can expect a friendly budget this year. This is the one sector that has been worst affected by the demonetization. One can look forward to additional tax incentives for housing developers, special benefits for low-cost housing, higher exemption limits u/s 24 of the Income Tax Act for interest paid etc. We can also expect quicker action on the REITS front so that it emerges as a credible instrument for investment.
- Capital gains could see a tweak in this budget. We have already seen the government’s intent to make taxation as progressive as possible. Last year, the government imposed an additional 10% tax on dividends for investors receiving more than Rs.1 million per annum as dividends. This year the definition of long term gains could possibly be modified to 3 years instead of the current 1 year. However, we expect the LTCG to continue to be tax free for the time being.
- Then there is the issue of reduction of Securities Transaction Tax (STT) on equity market transactions. However, considering that the government has recently reduced the STT rates for various asset classes, any further cuts are largely ruled out. There is also demand for providing rebate for the STT paid, which was withdrawn a few years ago. However, the government is of the view that STT rebates were being used for STT transfers and therefore became a means of creating black money. Considering the government stance on black money, this relaxation looks unlikely.
- Digitization of money could be the big theme of the Union Budget. The budget is expected to extend special tax incentives for manufacturers of POS machines, creators of software for POS machines, last mile support providers etc. The budget is expected to make an effort to incentivise domestic players in these segments with a variety of tax incentives. That could have a salutary stock market effect on these stocks.
- The government may make an effort to boost retail participation in equities through the ELSS route. Currently, the ELSS is carved out of the overall limit of Rs.150,000 under Section 80C. Considering the plethora of instruments covered, this limit is grossly inadequate. This budget may either expand the limit of Section 80C to Rs.200,000 or could give an additional limit of Rs.50,000 purely for ELSS schemes.
- There is a demand to extend the definition of STCG and LTCG on equity mutual funds to debt mutual funds too. However, considering the distortions that it may cause, such a move is unlikely. This Budget is likely to announce a special measure for putting Fund-of-Funds (FOFs) on par with other equity funds. Today, even if the FOF is a collection of equity schemes, it is still treated as a debt scheme for LTCG and STCG purposes. This anomaly may be removed to encourage the spread of FOF market in India.
- There is also an expectation that Section 54EC may be extended to mutual funds once again. This section enables investors who have made long term capital gains to avoid paying the capital gains tax by investing the proceeds in specified assets. In the past, mutual funds were eligible assets, albeit with a longer lock-in, but that was subsequently removed. That facility is expected to be reintroduced in this budget.
- The big takeaway for the capital markets could be the cut in corporate taxes. The government has already promised to bring down the corporate tax rate from 30% to 25% over a period of 4 years. To outweigh the impact of demonetization, the government may look to implement a 2% cut in tax rates which will substantially enhance valuations for Indian companies.
- The government may put out an income transfer program for the first time in history. The government is flush with funds after demonetization and the proceeds of the black money declarations can be paid out directly to underprivileged sections. Additionally, the government will also try and replace the demat account with an Aadhar card driven KYC. This will help the smaller and rural investors participate in the equity markets with greater ease. This could be a big boost for the bottom-of-the-pyramid investment market.
The Union Budget 2017 is likely to be an interesting one for capital markets. It could be a mixed bag! On the one hand the government may open up the bottom of the pyramid markets in a big way benefitting equities substantially. On the other hand, the government is likely to take stringent measures to control black money and make equity profits more accountable. The result could be an interesting basket for equity markets!