It may sound a tad surprising that the GST is also likely to impact the capital markets. The normal query is how can a goods and services tax (GST) really impact capital markets. There could broadly be three kinds of shifts that are likely to happen in the capital markets in the post GST scenario. Firstly, there could be a greater preference for long term investing over short term investing and this will apply to equities and mutual funds. Secondly, there will be a preference for equity as an asset class over other classes of assets. This is likely to gradually manifest over the next few months and could impact financial planning metrics in a big way. Lastly, GST may see the rise of passive investment as a distinct asset strategy, the way it has emerged in the West. Let us look at each of these trends in greater detail..
1. Trend 1 – A case for long term investing over short term trading..
Remember, the equity market is made up of short term traders and long-term investors with both having a distinct role to play. While short term traders help in narrowing the spreads in the market and creating liquidity, it is the job of long term investors to help discover value. With GST being effective from July 01st, the effective rate of service tax at 15% stands modified to 18%. Remember, till June 30th, equity investors were paying service tax at the rate of 15% (14% service tax + 0.5% Swachh Bharat Cess + 0.5% Krishi Kalyan Cess). Effective 01st July, this activity will attract 18% GST. Assuming that you pay 1% in the cash market as round brokerage, your GST impact will be higher by 3 basis points. While this may not make a big difference for long term investors, it will definitely change the economics for short term traders. When you churn in and out of positions on a consistent basis, the additional 3 bps that you will be paying as GST will add up to quite a bit. This will create a preference for long term investing with less of churning.
Even in case of mutual funds, the Total Expense Ratio (TER) of an equity fund is estimated to go up by 5-6 basis points as a result of GST. Fund managers who churn less will be able to widen their performance over the more frequent churners as the impact of GST will gradually add up for them. GST will drive investors a little more towards serious long-term investing over short term trading.
2. Trend 2 – Equity will emerge as a smarter asset class to play growth
Over the last 3 years, we have seen tremendous fund flows into equity mutual fund through the SIP route underlying the rising retail interest in equities. With other asset classes giving tepid returns, investors are increasingly looking to equity to generate alpha. So, what will change after GST? Remember, GST is not just about rates but two additional important factors. For example, the global experience has been that GDP of countries implementing GST tend to see an accretion of up to 3% in their overall GDP. On a GDP base of $2.5 trillion, that is likely to create an income effect of nearly $75 billion in the next couple of years. We can conservatively apply the Market Cap / GDP ratio and calculate how much of a wealth effect this will have. The moral of the story is that equities will be the best way to play this growth. Secondly, the implementation of GST will create a major structural difference to the distribution and logistics metrics of large companies. This will especially impact companies that operate in sectors like automobiles, two-wheelers, consumer durables and FMCG that operate national networks. With the doing away of state level taxes, the focus will shift to creating distribution and logistics networks based on business needs rather than based on state taxes. The impact of this shift on valuations of these companies will be massive and can be best captured by investing in the equity of these companies.
3. Trend 3 – Will GST lead to the rise of passive investing in India
That is a tough call, but not entirely off the mark. Passive investing is all about indexing your portfolio performance to an index like in the case of an index funds and equity ETFs. The additional 5-6 bps cost created by GST will make a further case for these passive funds. The shift may not happen immediately when alpha opportunities are still available aplenty. However, once the market gets more volatile and alpha opportunities less frequent, then passive investing may see a revival of interest.
An impact on equity investing is definitely on the cards in the post-GST scenario. The case for equities and the case for long term investing could actually get stronger due to GST. But GST may actually force money managers to tweak their strategy in the light of the emerging opportunities and also in the face of higher cost of transacting. This will apply to fund managers, PMS service providers and also to financial planners. It may be time for a strategy shift!