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Saturday, Jul 10, 2004

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Opinion - News Analysis

The Budget and the stock markets

By C. R. L. Narasimhan

The day before the Union Budget the market sentiment was mildly optimistic. A two-day rally had taken the indices on Wednesday to, by recent standards,

acceptable levels. The Sensex had closed at 4955 and the Nifty at 1566. On the Budget day there was considerable confusion even in understanding the Finance Minister's speech. That was manifest in the ways the market reacted: heavy volumes matched the volatility as the indices swung first down and then moved up smartly, with the Sensex crossing 5000 at one stage, only to drop well below the previous day's close. At the end of the day it was sharply lower by 112 points.

<167,2p,1>P. Chidambram's Budget is focussed on agriculture and the rural sector. That approach, of course, is entirely consistent with the Common Minimum Programme. (CMP). In fact a greater part of his speech was devoted to agriculture and social sectors and most certainly every one was keen to know the means to fund the increased outlays. As the tax proposals, especially the new ones — the cess on all kinds of taxes for education and the transaction tax — were announced towards the end of the Finance Minister's speech, the market's rather extreme reactions came at the fag end of trading on Thursday.

Did the market overlook the many positive features of the budget? Specific to the capital market, the following measures have a direct impact: abolition of long- term capital gains tax and reduction of short-term capital gains tax to 10 per cent; proposals to integrate commodities market with securities market (using the same trading platforms and other infrastructure). A move that has gone largely unnoticed is the raising of the FII ceiling in debt funds from $1billion to $1.75 billion. Streamlining procedures for facilitating greater FII flows through easier registration and subsequent operation in India is another pro-capital market move.

On the negative side, of course, was the transaction tax at 0.15 per cent of the value of the securities. According to practically every luminary — analysts, industrialists and celebrities — this new tax is the main reason why the indices sunk on the Budget day.

Any new tax proposal such as the transaction tax is bound to be intimidating. When the Finance Minister first announced the tax, only brief details were available: that it will be applied uniformly on all securities transactions undertaken through the stock exchanges and that its incidence will be on the buyer of the securities. The benefit claimed on its behalf was that it would replace the long-term capital gains tax and also make possible for a lowering of the short-term capital gains tax in stock market transactions. In their totality the new proposals are aimed at creating a level playing field between Indian and foreign institutional investors.

The Exchequer gains because the scope for avoidance is considerably reduced. As against that, its perceived disadvantages are several. Even the rate prescribed, Rs.150 for every Rs.1 lakh transaction was considered to be on the high side. It did not help that the Finance Ministry was slow in clarifying the implications of the new tax. For instance, at the end of the trading day there was a report that the tax will only be on delivery-based transactions that account for only a fourth of the capital market transactions in India. The report however was discounted and as things stand today the transaction tax will cover all types of securities transactions, equities, both cash and forward market and bonds. Its incidence will be on the buyer.

Was it a knee jerk reaction of market operators to a budget, which has to be evaluated only over the medium term? The thrust on the rural sector, as every industrialist who appeared on the TV on Thursday agreed, should generate more purchasing power and will therefore be for the good of the manufacturing sector and the macro economy. Besides, fiscal consolidation far from being diluted is to be pursued with a renewed vigour and now be dictated by the strict rules of the FRBM Act (that were notified just days before the Budget).

Economic reform measures have also found a place. Under disinvestment the budget takes credit for Rs. 4, 000 crores, roughly a fourth of what was achieved last year. Yet the significance lies beyond numbers. The Finance Minister has revived an institution akin to the Disinvestment Commission to restructure public sector undertakings before selling part of their stake. Most impressive, of course is the hike in the FDI ceiling from 26 to 49 per cent in insurance, 49 to 74 per cent in telecom and 40 to 49 per cent in the case of civil aviation.

In many ways, the Budget is an exercise in continuity and has not overlooked the reform agenda. Unfortunately the market's focus on just one tax proposal and the Government's inability to clarify its implications have harmed the sentiment. The partial recovery on Friday does not in any way alter the situation.

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