Friday, September 26, 2008

Uncertainty rules the sentiments on the Street

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Although there may be long-term positive effects of the various Budget proposals this year, investors, traders and speculators seem unhappy with the Finance Minister, writes gyanendra kashyap

The Sensex high of 20,873.33 (in January, 2008) was followed by the bloodbath later in the same month. But that’s not where the tragic tale ends. The fact is that the market has come down by nearly 22%, thanks to global cues arising out of concerns that the US economy is on the verge of a recession. Amidst such a choppy ride, the Union Finance Minister, while presenting his recent Budget (an election one by all means) only added to the woes of the nervous primary and secondary markets. Investors in stocks and commodity exchanges have to now gear up to grapple with a few unfriendly measures. The proposed hike in short-term capital gains tax, bringing transactions in the commodity exchanges under the transaction tax net (on the lines of Securities Transaction Tax), and spreading the service tax net to cover stock and commodity exchanges, as well as the depository and clearing corporations are going to affect volumes and dent sentiments. The $15 billion loan waiver (termed as an ‘emergency measure’ by the finance minister) to benefit 40 million ‘distressed farmers’ has further hit the banking sector. Considering the uncertainty over the burden of the losses to be shared by the banking sector, the share prices of banks have dipped, so much so that the share price of the largest bank, SBI, declined by close to 12% to touch Rs.854.15 (on March 5, 2008) since the Budget day. And despite mixed responses to the Budget, the numbers at the BSE show no confusion – it’s not something to smile about!

Of the several surprises that the Finance Minister, P. Chidambaram sprung, the most debated ones have been the hike in the short term capital gains tax from 10% to 15%, and the introduction of commodity transaction tax. However, considering that the tax on short term capital gains had been reduced from 20% to 10% in the last Budget, a 50% increase this year is not likely to have a major impact in the long term. Subhasis Gangopadhyay, Advisor to the Finance Minister, observes, “The short term capital gains tax has been introduced to promote long term investment.

It is not going to make much of a difference.” The FM had himself stated in his speech that there was “merit” in equating the taxes on short term capital gains and dividend distribution tax. Conclusively, it is a prudent measure to curb speculation and induce long term investment. The logic seems to have found support from experts as they feel that increasing the tax rate will further encourage investors to have a longer range commitment and discourage unhealthy speculation. The Mutual Fund industry has been optimistic about the proposal. Ajay Bagga, CEO, Lotus India Asset Management, says, “It’s better, the churning will be stopped which is what we in the industry look forward to as long term investors. It will restrain investors from short-term liquidation.” Agrees Sandesh Kirkire, CEO, Kotak Mahindra Asset Management, “The rise in short term capital gains is a positive step taken to make the domestic investors elongate their investment horizons.”

The fact that service tax will be imposed on Unit Linked Insurance Plans (ULIPs), a move to create a level-playing field with Mutual Funds, has brought in the much-needed enthusiasm. Yet, few argue that it is a big market dampener for sentiments and more so for the foreign institutional investors (FIIs). The brokerages feel that it would impact sentiments negatively (trading volumes will be hit) in the short run. From a macro perspective, it will not hit businesses hard, for as the market progresses from speculation-based trading to a more fundamental and value-based one, the opportunities for making money would not be totally missed. Agrees Srikanth Velamakanni, CEO, Fractal Analytics, “While it is an unpopular move, and the market has reacted negatively to it, the move may be useful for small investors because it would reduce the volatility of the market and incentivise investing for the long term.”

Any introduction or raising of taxes is sentimentally not very welcome. “With the addition of Commodities Trading Tax, the market will become unusable for risk management,” complains Jignesh Shah, MD & CEO, MCX. Analysts agree that the introduction of the tax is bound to adversely impact the already-nervous secondary and primary markets. The disenchantment to this can be gauged from the fact that the commodities market regulator, Forward Market Commission (FMC), has countered saying that it was wrong to compare the commodities and the equities market since both had a different character altogether. Further, it has taken up the cudgels on behalf of the commodity exchange to exempt futures trading from the proposed tax. Perhaps, the FMC is yet to learn the “no rollback” comment of the Finance Minister during his interactions with the CII National Council members. The proposal will amount to a 0.017% levy on options premium and the sale price of a commodity derivative. The purchaser will be required to foot in 0.125% on settlement prices of options in commodity derivatives or goods. Adds Shah, “Indian commodity market will become inefficient and not serve its economic purpose of enabling risk management at this cost of trading, which is far inefficient compared to global cost, and business will migrate from regulated exchanges to international markets or unofficial local market.” This could lead to a tapering off in secondary market liquidity, and a further drop in the liquidity on the commodity exchanges.

The change in the treatment of securities transaction tax as a deductible expenditure against business income, and proposing a tax on services of stock exchanges will further hit sentiments. The changes in securities tax would result in a higher effective tax outgo, which will impact volumes of day traders and arbitrageurs. Bringing it under the service tax net will increase the transaction cost for traders and investors. According to Amitabh Chakraborty, Economist, Religare Securities, “Arbitrageurs and traders will be the most hit. They are the ones who create liquidity in the market.” The move would have been welcome had it been introduced when the market was in a bull phase.

The Budget has not met the expectations of many, argues Gary Bennett, Managing Director & CEO, Max New York Life Insurance, “The FM has not taken any specific action to promote long term savings, including investments for retirement through exemptions under section 80C.” Bert Paterson, MD & CEO, Aviva Life Insurance shares a similar opinion, “The Budget is yet another lost opportunity for the insurance sector. Instead, the asset management services for ULIPs have been brought under the service tax net which could have an adverse impact on long-term savings.” The market has responded to the Budget in a mixed fashion, but only when the proposals come into effect will we witness the actual impact. Considering the negligible effects, some of the proposed changes will be forgotten. Whatever be the case, the Sensex may anyway head southwards.

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Source : IIPM Editorial, 2008

An Initiative of IIPM, Malay Chaudhuri and Arindam chaudhuri (Renowned Management Guru and Economist).

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