To Cheer or Not: Budget Dilemma

The maiden budget by the new government was announced yesterday. While some say its reform-minded budget others say it is a missed opportunity. In our view, this budget brought out mixed feelings amongst the financial analyst and common man. The lawyer politician and now the Finance Minister Mr. Jaitley did try to cheer the common man and planned some long term measures to fix the ailing economy, but there were big expectations that are either missed or in our view, not thought through prudently.

Here is Quantum's take on the budget. We have divided this into 5 small sections, giving you a snapshot of each, as to how this affects you as an investor and your investments in mutual funds.

Cheer for the common man

The increase in the tax exemption limit by Rs. 50,000; doled out via an increase in 80C limit by the same amount is cause for cheer for the small investor. This takes the tax exemption limit to Rs. 150,000 instead of the earlier limit of Rs. 100,000. PPF limits have also been raised to Rs. 150,000 so that the small investor can avail of the full deduction benefit by investing in PPFs.

An increase in deduction of interest paid on housing loan by Rs. 50,000 also aims to bring relief to the common man. Although, not a consumption boost, but this should help increase the savings; which is a good step, as financial savings in the last 3-4 years haven't increased by much. This should have a positive impact for the economy.

Cash grants and efforts towards women safety, blind and differently abled citizens were also announced.

Mutual Fund Investors

The budget dealt a hard blow to investors in non-equity schemes of Mutual Funds. The long term capital gains taxation in these funds was changed in two ways;
a. the tax rate was increased from 10% to 20%;
b. the tenor of holding to avail of the long term capital gains tax benefit was raised from 12 months to 36 months.

This was primarily done to bring investment in bank deposits and debt mutual funds at par from a taxation perspective.

FMPs of 1 year+ will be the most impacted due to this ruling; as most investments in just above 1yr FMPs were driven largely due to the capital gains tax of 10% after 1 year as against the taxation on FD of 30%.

FMPs and the overall universe of non-equity schemes constitute a large proportion of the AUM of the mutual fund industry in India.

Quantum Mutual Fund, unlike the industry, has a predominantly equity portfolio and does not launch FMPs but we do have liquid, fund of funds and gold funds which fall under the non-equity category. Even equity fund of fund schemes are (we believe wrongly so) clubbed under the non-equity scheme umbrella and hence investors in all these above schemes will be affected by the new rule.

To offset this huge negative is a small positive of streamlining the KYC norms across all financial entities. This has been debated in the past and is easy to put on paper but the on ground challenges to operationalize this are quite daunting. Mutual funds, Insurance companies and most importantly banks will have to build a common platform to securely share customer data and details. If this does happen, it will make the investor's lives a lot simpler since this will cut out the need to do KYC multiple times across the Indian investment spectrum.

Impact on Individual Asset Classes

The impact on individual asset classes of the budget are discussed below.

Equity

Finance Minister Arun Jaitley has lived up to his image of a fiscal hawk by sticking to the fiscal deficit target for the year. The plan to reduce the fiscal deficit gradually to 3% from the levels 4.1% of GDP is good for economic health. The focus of the budget has been on increasing manufacturing activity, agricultural growth and controlling inflation through investment in storage.

There is also an intention in simplifying taxes aimed at attracting FDI probably it will disappoint those looking for big - bang reforms from new government. However, the budget appears to be pragmatic.

The markets however had a roller coaster ride yesterday with swings of almost 800 points being seen in one day. The short term cheer that the market was looking for has obviously not been delivered by the budget, but the long term plans being charted by the Government and the budget seem to be on the right track, with the aim to boost infrastructure, power, real estate and domestic steel sectors.

There were some good measures undertaken for the tourism, textiles and real estate sectors in terms of easing the duties on some of the items, whereas companies in the FMCG (aerated water with sugar and cigarettes) and imports oriented sectors have cause for complaint due to increased duties.

Debt

The finance ministry has indicated it will maintain the fiscal deficit of 4.1 % for the financial year 2014-15, 3.6 % in 2015-16 and 3 % in 2016-17. The government has also stated it will target food and fuel subsidies. It will introduce GST to increase the tax to GDP ratio to make doing business simpler. These measures are very progressive and good for the bond markets and equity markets. It would lead to reduction of inflation in the coming years due to lower fiscal deficit.

The government has increased the FDI in defense to 49 % to increase the local indigenous production and save precious foreign exchange. These measures will reduce current account deficit in the long run. This should lead to the currency remaining relatively stable in the long run as current account deficit will be at manageable levels. Overall, the government has given a roadmap which it intends to work on over the next 5 years and increase the supply of goods and services in the economy.

Gold

"As for gold, it is proposed to reduce the customs duty on imported gold to Rs.100 per 10 grams from the present level of Rs.250 per 10 grams, but only when it is brought in the form of serially numbered bars, or in the form of gold coins, not as 'tola' bars. It is my hope and expectation that this will become the first step in enabling India to shortly emerge as the gold-trading capital of the world."
- Jaswant Singh (Finance Minister - 1999-2004)

The above is a verbatim quote from the budget speech of the year 2003 - 2004 on gold that provides a perspective of the government's commitment towards the development of the gold market, then.

While it is the same party, they don't really seem to share the same set of views. This year in 2014, the BJP government yet again got an opportunity to decide the budget for the year ahead which could have been a stepping stone for rationalizing the gold market. Even though they strongly are in support of less government and more governance, ironically when it comes to gold it is the exact opposite that is happening, it's more government and less governance. The gold market is still facing a lot more interventions from government.

In two ways:
1.There are no free imports or free exports,
2. Tariffs applicable on gold.

We would have liked to see measures to bring domestic prices on level with international prices so as to bring about an efficient two way transfer of the commodity or currency. This will help lay down some basic rules in order to find the true price of that commodity or currency. For this to become successful, additional taxes, duties and levies need to be abolished.

It is essential to liberalise the policy on gold. Removal of tariffs and freeing the market are the prerequisites for this development. There were some efforts made in this direction and now it seems that the previous government reversed all the prior efforts. And in our view this budget has done nothing to correct it.

To conclude...

Overall, from a long term perspective; the government's agenda of fiscal consolidation through an increase in Tax/ GDP (better compliance; widening of the tax base; implementation of GST) than through cut in needed expenditure is worth getting excited about. But the budget fell short of a major push to growth and infrastructure; not to mention the dampening news about the capital gains tax from a Debt investment perspective. In our view the Finance minister's maiden budget maybe strong on intent but it failed to provided details on revenue and expenditure measures to lower India's fiscal deficit as well as lacked a big vision statement in it. The Finance Minister knows there are many economic risks on the horizon coming largely from an impending drought situation and potential inflationary flare up, not to mention the struggle for order in Iraq and the volatile middle east, the Crimea region etc. which could impact India's largest import - oil; in the months ahead.

Thus the question - whether or not to cheer the budget, still remains true.

Above article is authored by Quantum.

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