India whacks tax on investors
The first budget of Narendra Modi's third term has raised the tax burden on investors, while spending heavily on infrastructure, especially in states ruled by the Indian prime minister's new coalition partners.
In her budget speech on Tuesday, finance minister Nirmala Sitharaman raised the capital gains tax on specified financial investments, including equities, to 20% from 15% for investments held for less than one year and to 12.5% from 10% for financial and non-financial investments held for more than one year, effective immediately. She also removed the indexation of long-term capital gains for property and gold investments.
Furthermore, income received by shareholders from company share buybacks will be subject to income tax, in line with the treatment of dividends. In India, companies generally buy back shares via formal tender offers at a price higher than the market price.
Sitharaman also increased the securities transaction tax on securities derivatives "in view of [the] exponential growth of the derivative markets". The STT on futures trading has been increased to 0.02% from 0.0125% and on options to 0.1% from 0.0625%.
According to budget figures, STT receipts should total Rs370bn (US$4.4bn) in the current fiscal year (ending next March), up 15.6% from the previous year.
The government also increased the capital gains tax for Alternative Investment Funds which invest in unlisted bonds, whose issuance volume touched an all-time high in the past year.
Any gains on the transfer, redemption or maturity of unlisted bonds will incur the short-term capital gains tax, irrespective of the actual holding period.
The tax increases came as a surprise to analysts, who were expecting tax breaks ahead of regional elections in some states later this year.
"The market is touching all-time highs, so by raising short-term and long-term taxes on equity investments, the government is increasing its revenue share through taxes," said Sandeep Bagla, chief executive officer at Trust Mutual Fund.
On the spending side, the states of Bihar and Andhra Pradesh are the big winners, as they are ruled by parties that form part of Modi's governing coalition after the prime minister's Bharatiya Janata Party lost its overall majority in this spring's elections. The government has allocated Rs260bn to Bihar for road projects, new airports, power plants, medical colleges and sports infrastructure and Rs150bn to Andhra Pradesh for the development of its capital Amaravati.
Despite the higher spending, the government was able to lower the fiscal deficit target for the current fiscal year to 4.9% of GDP, down from 5.1% forecast in the interim budget in February, and to 4.5% in the next fiscal year. The improvement was made possible after the Reserve Bank of India announced a record dividend transfer of Rs2.11trn to the government in May, more than double the estimates.
Gross government borrowing will also be slightly lower at Rs14.01trn compared to Rs14.13trn announced in the interim budget.
Short-term negative
The increase in the capital gains tax could be a negative for the equity markets in the short term.
"There will be a squeeze in the profits which investors were making in equity," said Bhavesh Chauhan, head of research at Aditya Birla Money. Bankers expect retail and high-net-worth investor participation in IPOs to fall, which would have a material impact as nearly 50% of a deal is reserved for them.
According to a study released last week by the Securities and Exchange Board of India, the number of intraday traders in the cash equity market jumped 300% from 2019 to 2023. Seven out of 10 made losses, according to the market regulator.
"We could see a slight impact on large IPOs, because short-term capital gains tax is increased, as some investors were investing in IPOs for listing gains," said Suresh Parmar, head of institutional equities at KJMC Capital Market Services.
Among the big IPOs planned this year are Hyundai Motor India (US$3bn–$3.5bn), Ola Electric (US$800m), Swiggy (US$1bn–$1.25bn), Afcons (US$975m), Bajaj Housing Finance (US$1bn) and Vishal Mega Mart (US$1bn).
Indian shares fell around 1% intraday on budget day but pared back the losses to around 0.6% from pre-budget levels later in the week.
"India ECM will remain active as it is one of the few markets where one can still make money. Investors will complain for a few days and then it will be business as usual," a Mumbai-based ECM banker said.
Unlisted bonds hit
Analysts say the tax changes will also have a detrimental effect on the bond market.
"The government has proposed to tax unlisted debentures at a higher rate as per the tax slab, which is 30% for resident Indians, non-residents (other than foreign companies) and FPIs and 35% for foreign companies. The higher tax rate on gains could increase the cost of unlisted CCDs/NCDs deals and potentially affect the debt deal landscape," said Vinita Krishnan, executive director of direct tax at law firm Khaitan & Co.
Earlier, a three-year holding period was treated as long-term and the tax rate was much lower, between 10% and 20% depending on the tax slab, or bracket, she said.
The higher taxes on unlisted debentures will slow down such deals. "Most of the private credit funds invest in unlisted structures, this change in taxation is going to impact the returns from private credit deals," said a head of a private credit fund.
Infrastructure focus
The government has retained the 2024–2025 disinvestment target of Rs500bn set in the interim budget.
However, no new IPO plans were announced for state-owned companies. ECM bankers were expecting stake sales to be announced for National Payments Corporation of India, Central Warehousing Corporation, National Seeds Corporation and Export Credit Guarantee Corporation of India.
The government continues to focus on infrastructure. Capital spending has been maintained at Rs11.11trn, or around 3.4% of GDP, to build roads, airports and ports. It will also invest in job creation and rural development after the recent election setback.
India's 10-year benchmark hovered around 6.95%–6.98% last week, hardly affected by the budget announcement. Fund managers expect bond yields to soften to reflect the continuing fiscal consolidation.
"We will continue to see an easing bias for the bond markets on [the] back of lower supply and continued demand from foreign investors on [the] back of the JP Morgan bond inclusion and buying by domestic investors, although there is no visibility of a rate cut in the near term," said Lakshmi Iyer, CEO of Kotak Alternate Asset Managers.