It is natural to look at the Union Budget each year from the point of view of the equity markets. The Sensex and the Nifty have been the barometers of market value and market sentiments and their gyrations best reflect the market interpretation of the Union Budget. If you look back at the last 2 years, the Union Budgets of 2016 and 2017 had been instrumental in giving a big boost to the equity markets. In fact, if you look at the Nifty and Sensex from the Budget day on 2016, then the indices are up by over 50% in less than 2 years. That is surely an emphatic thumbs-up for the last 2 Union Budgets. So, what exactly are capital market expecting from the Union Budget 2018-19?
Don’t let the fiscal deficit spill out of control
The last 2 years the government has managed to keep the fiscal deficit in check despite higher outlay commitments. This was well received by the markets and also eventually led to the sovereign rating upgrade by Moody’s. In the current fiscal year, the government has already touched 112% of its fiscal deficit targets in the first 8 months itself. While the fiscal deficit target for the year is 3.2%, it has kept a leeway of 50 basis points. As long the level of 3.7% is not breached, there should not be a problem. For the next year, the government should not exceed the target of 3% by more than 30 bps. Markets understand the need to pump prime the economy. As long as the fiscal deficit remains in the range, markets should be satisfied.
Rationalize DDT and tax on dividends
The markets are expecting the government to do a rethink on the 10% tax on dividends above Rs. 1 million that was recently introduced. This is leading to triple taxation of dividends. Firstly, dividends are a post-tax appropriation. Secondly, dividends are already subject to DDT. Now the 10% tax on dividends in the hands of the shareholders is leading to triple taxation. Markets are hoping that this will be rationalized through one of the methods. Either the limits of the taxable dividend can be enhanced from Rs.1 million or DDT can be scrapped. However, considering the government’s commitment to progressive taxation, this may not happen in this budget.
Give a big boost to infrastructure and rural spending
That has always been the booster dose for the economy and the markets. Infrastructure has strong externalities and hence has a multiplier effect on growth. The government spending on roads and highways has been a big boost to growth and that is expected to continue. The big stress on GDP growth came from agriculture. With the government committed to doubling farm incomes by 2022, the expectation is of a big push to infrastructure and rural spending in this budget.
A corporate tax cut; but, no LTCG please!
The government had promised a progressive cut in tax rates from 30% to 25% but also a simultaneous removal of exemptions. That will make the announcement neutral. The expectation is a cut in corporate tax rates and phasing out exemptions in a time-bound manner. After all, even the US is aggressively pursuing corporate tax cuts. Indian corporate tax rates are already among the highest in the world. The market also hopes that the LTCG on equities is not re-introduced. Tax free LTCG has been a key driver for investments in equities. However, an increase in the time limit for LTCG from 1 year to 3 years looks possible to foster a longer term approach to equities.
Including equity under ELSS definition
There are two aspects to this point. Firstly, the ELSS includes only equity mutual funds and that is narrowing the definition of eligible investments under Section 80C. In the past equity investments in infrastructure were also eligible under Section 80C subject to 3 year lock in. It is time to reintroduce that section. Also the benefit under ELSS is too small. In fact, a separate sub-section under Section 80C can be introduced for ELSS and Infrastructure equities with a separate sub-limit. That will give a big boost to long term investments in equities.
Including mutual funds for Section 54EC benefits
Section 54EC benefits are available when long term capital gains are reinvested in specific infrastructure bonds with a lock-in period. In the past, mutual funds and infrastructure equities were also included under the definition of eligible investments under Section 54EC of the Income Tax Act. In fact, if the government goes ahead and enhances the cut-off for LTCG on equities to 3 years, then extension of Section 54EC to equities will be a good measure to neutralize the effect. Again this will be a big boost for investors to look at equities for the long term.
A boost for purchasing power of investors
Lastly, the one thing that markets always expect is a boost for purchasing power of small investors. In the last few years domestic mutual funds have emerged as much bigger players than FPIs in terms of flows into Indian markets. That has been largely driven by retail savings surpluses. The budget is expected to give a big boost to retail surpluses in the form of lower tax rates, higher tax exemptions etc.
At a procedural level, it is also expected that the process for on-boarding of FPIs will be made simpler and also that the pending tax issues pertaining to large companies like Vodafone, Cairn and Nokia are amicably resolved. That will be a big boost for market sentiments. After all, markets are substantially about investor sentiments!