The Union Budget presented in July proved to be a mixed bag, with Finance Minister Nirmala Sitharaman focusing on long-term growth measures to revive the agriculture sector and the larger economy. However, one particular measure that did not go down well was a higher tax surcharge proposed on the super-rich.
While the basic tax slab was kept unchanged at 30 per cent, the surcharge was hiked to 25 per cent from 15 per cent for individuals whose taxable income is between Rs2 crore and Rs5 crore, and to 37 per cent from 30 per cent for those earning over Rs5 crore. The increase in surcharge would mean that the effective tax rate—including 4 per cent cess—for those with an income of Rs2 crore to Rs5 crore would now be 39 per cent, and for those above Rs5 crore the tax outgo would go up to 42.74 per cent.
This higher tax outgo is likely to impact an estimated 40 per cent of the foreign portfolio investors (FPIs) investing in India. They are a worried lot, considering that this comes at a time the economy has slowed and corporate earnings remain lacklustre.
After pumping around Rs78,600 crore between January and June 2019, foreign institutional investors (FIIs) pulled out Rs12,400 crore from equity markets in July, even as they channelled in more than Rs9,000 crore in debt markets. The FII pullout led to the benchmark BSE Sensex falling more than 6 per cent in July.
“The budget announcement on taxation has adversely impacted investor sentiments and is reflected in the FPI outflows from the equity markets,” noted Sushant Hede, associate economist at CARE Ratings.
There were, however, also proposals in the budget aimed at attracting more FIIs to India’s stock markets. For instance, it has been proposed to increase the statutory limit for FPI investment in a company from 24 per cent to a sectoral foreign investment limit with option given to the concerned corporates to limit it to a lower threshold. FPIs will also be permitted to subscribe to listed debt securities issued by REITs (real estate investment trusts) and InvITs (infrastructure investment trusts).
The higher tax surcharge on the super-rich was not the only thing that spooked investors. They were left concerned after Sitharaman proposed that the Securities and Exchange Board of India (SEBI) consider increasing the minimum public shareholding in listed companies to 35 per cent from 25 per cent.
Increasing public shareholding in listed companies will lead to wider ownership of shares and deepen the market further. The move could also attract to the market foreign and institutional shareholders, who are keen to pick up some of the marquee stocks.
However, it would also pose a challenge for many top listed companies, including multinational corporations, who would have to bring down the promoter shareholding from 75 per cent to 65 per cent. Those who are not keen on it, may instead consider delisting their companies from Indian bourses.
According to a study by Jagannadham Thunuguntla, senior vice president at Centrum Broking, there are 1,174 companies, or close to 25 per cent of the total 4,700 listed companies, that had a promoter shareholding above 65 per cent. Promoters of these companies would have to pare their stake further if the market regulator is to go ahead and implement the proposal. “The quantum of sale that needs to be done by these 1,174 companies works out to about a whopping 03.87 lakh crore,” said Thunuguntla.
Among top companies that would have to divest the most are TCS, Wipro and Avenue Supermart (the owner of DMart supermarket chain) that have promoter shareholding of 72.1 per cent, 73.9 per cent and 81.2 per cent, respectively. Bandhan Bank, HDFC Bank, Hindustan Unilever, ABB, Abbott, Bosch, GlaxoSmithKline Pharma, Honeywell Automation India and Siemens are some of the other companies that would have to shed more than 5 per cent of promoter stake to comply with the proposed norms.
If not given enough time, it could lead to a flood of new paper into the market, which could suck up the liquidity. However, market experts feel if the proposal is implemented, it would be over a period of time, so that companies get enough time to take their decision.
“While we need to await SEBI regulations regarding how much time will be given to these companies to meet with these minimum public shareholding norms, the overhang of this requirement of off-loading of promoter shareholding can have significant impact on the markets and the specific stocks. The regulator needs to provide sufficient time to meet this requirement so as not to over-flood the markets with stake sales by promoters,” said Thunuguntla.
Similar norms were announced in 2010, when the market regulator had mandated minimum 25 per cent public shareholding in listed entities. At the time, companies were given three years to comply with the norms.
“This definitely cannot happen in one go. A sufficient timeframe will be given to companies to bring down the promoter stake, and over time, the additional supply will get absorbed,” said Mayuresh Joshi, portfolio manager at Angel Broking.
There are several state-owned companies, too, in which the government will have to substantially reduce its stake to comply with these norms, if and when implemented. The government is anyway going ahead with its divestment programme.
Disinvestment in public sector enterprises has been a key tool for the government to rein in its fiscal deficit target, given the shortfalls in direct and indirect tax revenue. For the year ending March 2020, Sitharaman has increased the divestment target to Rs1.05 lakh crore from Rs90,000 crore, proposed in the interim budget. This will be done via consolidation of state-owned companies in some cases, and strategic divestment in others.
Apart from launching offer for sale in individual companies, the government in recent years has also taken the exchange traded fund (ETF) route to pare down stake in PSUs.
In July, the government launched the sixth tranche of Central Public Sector Enterprises (CPSE) ETF. The government had set a base issue size of Rs8,000 crore for the sixth tranche. However, the issue got oversubscribed and the government exercised the green shoe option, taking the total offer size to Rs11,500 crore. CPSE ETF was first introduced in 2014 and has in subsequent tranches raised Rs38,500 crore.
An ETF is essentially a grouping of stocks that track an underlying index. For instance, several fund houses in India have the Sensex ETF that has a basket of stocks tracking the BSE’s benchmark Sensex index. In developed markets, ETFs could also contain bonds, commodities or there could be mixed ETFs.
Just like shares can be bought and sold, ETFs can also be traded on the stock markets, and thus are more liquid than normal mutual funds. The ETFs usually replicate the performance of the underlying index they track, compared with an active mutual fund, where the fund manager is looking to take bets that would help outperform the broader markets. ETFs also have lower expenses and fees.
The CPSE ETF tracks shares of 11 central public sector enterprises—ONGC, NTPC, Coal India, Indian Oil, Rural Electrification Corp, Power Finance Corp, Bharat Electronics, Oil India, NBCC, NLC India and SJVN.
Compared to some of the international markets, ETFs have not really taken off in a big way in India. Earlier, not much was done to promote ETFs, and lower fees and expenses meant distributors, too, did not get much margins by selling them. In turn, they did not promote them much. Furthermore, many actively managed mutual funds beat the benchmark indices, unlike in the more mature markets like the United States. So the active mutual funds always looked more attractive.
In the budget this year, Sitharaman may have just been able to draw the attention of retail investors towards at least the CPSE ETF. “ETFs have proved to be an important investment opportunity for retail investors and has turned out to be a good instrument for the government of India’s divestment programme. To expand this further, the government will offer an investment option in ETFs on the lines of Equity Linked Savings Scheme (ELSS),” said Sitharaman.
ELSS allows an individual investor a deduction from total income of up to Rs1.50 lakh under section 80C of the Income Tax Act. There is a lock-in period of three years, after which, an investor could continue to hold, sell or switch the units in the ELSS scheme.
Now, as per the budget proposal, the CPSE ETF will also get a similar tax treatment, a move that could also encourage long-term investments in state-owned enterprises.
There could be several advantages of investing in CPSE ETF, says broking firm HDFC Securities. “It enables large investment in blue-chip public sector enterprises without the constraint of market liquidity on the underlying individual stock. Investors will be able to diversify exposure across a number of public sector companies through a single instrument,” it said.
The PSU stocks selected in the CPSE ETF also have a lower price to equity (P/E) ratio, high dividend yields and are available at attractive valuations, HDFC Securities further added. However, it also notes that it is not very diversified and is skewed towards the energy sector.
Other wealth managers are not too convinced as far as CPSE ETFs are concerned. “We would not recommend CPSE ETF due to better investment avenues availability and with some risks associated: one, CPSE ETF consists of PSU stocks that are associated to energy sector, leading to concentration of risk to one sector. Two, PSU earnings can fluctuate depending on government policies, thereby it does not provide a clear long term view. Three, companies belonging to the public sector tend to suffer from slow decision making and lack of competitiveness, thereby resulting in reduced efficiency compared to private companies,” said Vijay Kuppa, cofounder of Orowealth.
Anant Ladha, founder of Invest Aaj for Kal, says granting investments in CPSE ETF a deduction under section 80C of the Income Tax Act is a welcome step, from the perspective that one more equity-linked instrument is being added to the basket, opening up another investment avenue for the salaried class looking to claim deductions. It will also help deepening of equity markets.
However, he too favours ELSS schemes over ETFs, for their underlying diversified investments. “ELSS schemes are much more diverse and have given better returns over the long-term compared with CPSE ETF,” said Ladha. In the last three years, the CPSE ETF has given returns of over 9 per cent. But, in the same period, ELSS has averaged over 11 per cent. Over a five-year period, too, ELSS funds have outperformed the CPSE ETF by a wide margin, Ladha pointed.
Just as the government has looked to generate more interest in CPSE ETFs and make them attractive, it also continues to push the national pension scheme (NPS) as a means to generate post-retirement income for the salaried class. In the budget, Sitharaman announced that withdrawals from NPS post maturity would finally be made tax-free, thus bringing it on par with other financial instruments like the public provident fund (PPF). This was a decision that the Union cabinet had already taken last year. But with it finding mention in the budget only now, its notification could be made soon.
So far, NPS had enjoyed an EET (exempt, exempt, taxable) status, wherein upon withdrawal, the NPS was partially taxable. Of the total accumulated corpus, 40 per cent had to be used to purchase an annuity plan. This portion was exempted from tax, although investors must remember that the annuity income is taxable as per the existing slab. Of the remaining 60 per cent of the NPS corpus, 40 per cent was tax exempt while 20 per cent was taxed. Now, effectively, the entire 60 per cent will become tax free.
“Under the existing provisions of section 10 of the act, any payment from the NPS Trust to an assessee on closure of his account or on his opting out of the pension scheme, to the extent it does not exceed 40 per cent of the total amount payable to him at the time of such closure or on his opting out of the scheme, is exempt from tax. With a view to enable the pensioner to have more disposable funds, it is proposed to amend the said section so as to increase the said exemption from 40 per cent to 60 per cent of the total amount payable to the person at the time of closure or his opting out of the scheme,” the finance bill says.
The finance minister has also proposed to allow deduction for employer’s contribution up to 14 per cent of salary from the current 10 per cent, in case of a Central government employee. Deduction under section 80C for contribution made to Tier II NPS account by Central government employees will also be allowed.
NPS can be one of the tools for the salaried class as a part of their investments towards building a retirement corpus. When you invest in NPS, the money is channelled to a mix of equity, government securities and corporate bonds. This, in a way reduces the risk that is generally linked to equity. There is an additional income tax exemption for individual subscriptions of up to Rs50,000 under section 80CCD1(B) of the Income Tax Act, which is over and above the Rs1,50,000 deductions that are allowed under section 80C. That could be another advantage.
In NPS, the fund management charge or service charge is as low as 0.01 per cent of assets under management per annum for the private sector and 0.0102 per cent of AUM per year for government employees.
Now, with withdrawals also becoming tax free, those particularly close to 50 or above should definitely contribute to NPS, to cash in on the additional tax benefits, said Ladha.
There are a few things that an investor seeking to contribute to NPS must consider, said Orowealth’s Kuppa. For instance, one has to invest for a very long term if she wants to accumulate a sizeable corpus. And, it is not a liquid instrument, which means one cannot withdraw fully before retirement. There is also the fact that 40 per cent has to be invested in an annuity plan of an insurance company.
“The investor has to decide if it is worth giving up extra tax-saving allowance, which can be invested in other instruments, but address the concerns of liquidity. In our view, NPS is still not an efficient tool to generate retirement income as the investor will be better off investing in equity-based mutual funds,” said Kuppa.
As can be seen, be it via the proposed increase in public shareholding of companies, or via CPSE ETFs or NPS, more money could certainly make its way to equity markets over time if and when the budget proposals are implemented. However, given the current environment of a slowing economy, tepid corporate earnings growth and troubles in the non-banking financial services sector, some would wonder whether it would be advisable for retail investors to buy stocks or put money in mutual funds now.
Since hitting a peak of 40,312.07 on June 4, the benchmark Sensex had fallen by 7 per cent by end of July. Joshi of Angel Broking says that in the short term, equity market is likely to remain “sluggish” and it is the debt holders who will make money. “A market re-rating hinges on earnings recovery, which is still only a hope. There could be some revival in consumption around the festive season and liquidity-related relief is expected in the second half,” he said.
Still, he says, systematic investments should continue in stocks. However, one should do a lot of due diligence and pickup quality stocks, Joshi added.
Many stocks currently have fallen sharply from their peak. For instance, small-caps are down 35 per cent from their peak in January 2018, while the mid-caps similarly have fallen close to 23 per cent, notes Sunil Sharma, chief investment officer of Sanctum Wealth Management.
While he expects markets to remain volatile in the near-term, there will be medium-term opportunities. “We continue to favour leadership stocks with competitive advantages and advise using times such as these to accumulate positions,” said Sharma.