What can the capital markets expect from the Union Budget 2018?

The Nifty and the Sensex have given stupendous returns since the last 2 budgets. Since the lows of the 2016 Budget day, the indices are up by nearly 55%. From the last budget presented on February 01st 2017, the indices have gained by more than 25%. Look at the chart below. Over the last 1 year, the Sensex and Nifty have given returns of 26.77% and 26.96% respectively, which is a very strong outperformance even for equities. What is the broad Union Budget 2018-19 expectations? Let us also look back at the effect of budget 2017 on stock markets and the likely impact of the union budget on capital market this year.


                                               Source: Bloomberg

As the government goes into its last full budget on February 01st 2018 (the 2019 budget will be a vote on account ahead of the general elections), the question is how are the capital market expectations panning out? Here are 5 broad expectations that capital markets have built this time around ahead of the Union Budget..

Please, no tax on long-term capital gains
There have been strong hints thrown by the finance minister that the tax breaks on long term capital gains may be re-looked at. Currently, equities and equity funds held for more than 1 year are classified as long term gains. Long term gains are entirely tax free in the hands of the investor. The first demand is to scrap or at least reduce the rates of STT. Currently, STT contributes nearly $1 billion to the government tax kitty. In a tight fiscal year, any such announcement looks highly unlikely. The bigger worry is on the likely decision to tax long term capital gains at par with debt. That would be a big disincentive for retail investors to invest in equity mutual funds and these funds have been attracting billions of dollars of retail money. Secondly, it could create a massive confusion on the status of loss write-offs and carry forward. The market will be extremely pleased if the budget leaves the LTCG alone, tries to rationalize STT or at least offers a rebate on STT paid.

There is triple taxation of dividends and that is too much..
This is a common complaint of many high net worth investors. Currently dividends declared by equities are being subjected to tax at 3 levels. Firstly, the dividend is a post-tax appropriation. Secondly, there is DDT that is deducted on dividends by the company at the rate of 15%. Additionally, investors earning more than Rs.1 million as dividends each year will also have to pay 10% tax on dividends. While the 10% tax may not go, the market is at least expecting the government to rationalize on the DDT. Alternatively, the markets will also be pleased if the current limit is raised from Rs.1 million to Rs.2 million. There is also an expectation that the government may look to impose some form of tax on companies using buybacks as an alternative to dividends.

Foreign portfolio flows need another big push
The current norms on P-Notes are too stringent. That is the route many investors prefer and the government need not really worry as there are sufficient checks and balances in place. Also the FPI on-boarding process can be made a lot simpler. FPIs have been tentative in equities last year. While this partly due to valuations, the uncertainty over cases like Vodafone, Cairn and Nokia is also an overhang. The FPIs will be happy if the government is willing to commit on the taxation front and define the contours of their tax liability.

How about some tax benefits on equities if you want an equity culture
The street is also expecting that equity and equity related instruments may get some additional tax benefits this year to broaden the equity cult in India. For example, the ELSS limit may be carved separately under Section 80C. Investment in select equities may also be included under Section 80C subject to a lock-in period of 3 years. The street is also expecting that the Section 54EC for saving capital gains tax will be extended to investments in select infrastructure funds and equity shares in the infrastructure sector. That will also encourage a lot of risk equity into infrastructure.

Markets still believe in the trickle down story
Markets still want big bang announcements that will have a trickle-down impact on the markets. Investment in infrastructure projects like Golden Quadrilateral, inland waterways, Sagarmala all have a salutary and multiplier effect on the stock markets. Similarly, the government is counting heavily on rural spending in the budget so that the rural distress is converted into a rural opportunity. There are a lot of sectors that will benefit directly from higher rural spending and the effect will directly be felt in stock prices. Above all, the markets are also hoping for a big defence opportunity to be opened up for Indian companies so that self reliance can be built along with a boost to Indian business models.

To what extent the budget benefits the equity markets remains to be seen. But the government is committed to developing the equity cult among small investors. To that effect, a few incentives for equities will be par for the course.