Do it yourself

The markets began to take cognizance of the broader developments and oscillated wildly between the extremes of greed and fear during the year. However, thankfully, markets managed to close the year on a rather satisfactory note. Most asset classes – equity, bonds, precious metals, base metals and real estate yielded decent returns for the year. Moreover, as we begin the new financial year (FY26), some of the key concerns, e.g., wider trade conflicts, geopolitical escalations, and fiscal implosions have peaked and showing some early signs of easing.

In India, the economic growth returned to the normal pre-Covid trajectory, as the base effect of FY20 and FY21 low growth tapered off, and external challenges mounted. Equity markets settled close to their long-term average valuations, after witnessing one round each of euphoria and despondency. Bond markets and INR have also managed to end the year on a rather optimistic note.

The following are some of the highlights of the performance during FY25.

Equity Markets

The Indian equity market managed to end the year in positive territory, despite showing negative in six out of twelve months. Indian equities underperformed the global peers. The benchmark Nifty yielded a return of ~5% (3% in USD terms), which was in line with the US markets (S&P500 +8%), and Europe (Stoxx600 +5%, DAX +21%) but much lower than China (Hang Seng +38%, Shanghai Composite +9%). Asian markets, ex China, were mostly negative, with Japan (Nikkei225 -10%), Indonesia (IDX-10%), Korea (KOSPI -10%) and Singapore (SET -15%) ending the year with decent cuts. The valuation premium of Indian markets to the other emerging markets therefore remained elevated.

Banks saved the day for Indian benchmark indices

The benchmark Nifty (+5.3%) performed in line with broader markets (NSE500 +5.4%, Smallcap 100 +5.4%); though midcap stock did somewhat better (Midcap100 +7.5%). The gains in benchmark indices were mostly led by banks (Nifty Bank +9.3%). Overall market cap of NSE was higher by 6.9%, explained by many new listings and outperformance of midcap stocks.

Sector-wise, Financials, Services, Private Banks, Pharma and Metals were top outperformers. Media, IT Services, PSU Banks, Realty, FMCG, Auto, Infra and Commodities were notable underperformers. Micro-sector-wise, Ship builders and EMS were outstanding. Renewable energy and real estate builders were notable losers.

2HFY25 witnessed 5/6 negative months

The benchmark Nifty50 yielded negative month-on-month (MoM) returns for five out of six months in FY25. The second half of the year was worst with five out of six months resulting in negative MoM return. However, the market breadth was negative in nine out of twelve months implying much higher volatility in the broader markets.

Institutional flows positive

Over institutional flows were materially positive for FY25. Net domestic and foreign flows in the secondary equity market amounted to Rs3591bn. Foreign Portfolio Investors (FPIs) were however net sellers of Rs2480bn in the secondary market, while domestic institutions pumped in a record Rs6071bn. FPIs were net sellers in eight out of the twelve months. The nifty-institutional flow correlation (73%) was decent in FY25.

Debt and Currency Markets

Indian debt and currency markets were volatile in tandem with the global trend. However, both bonds and INR managed to close the year on a buoyant note.

RBI cut the policy rates by 25bps and Cash Reserve Ratio for commercial banks by 50bps. The benchmark 10-year treasury bond yields eased to 6.58% from 7.11% a year earlier. USDINR weakened 2.6% to 85.59 from 83.35 a year earlier. Lending and term deposit rates were higher by up to 10-20bps. The yield curve shifted lower and flattened completely.

The RBI changed its policy stance to “neutral” from “withdrawal of accommodation” in FY24. The liquidity position however continued to remain tight, with banking system liquidity remaining in deficit for most part of the 2HFY25. The credit growth outstripped the deposit growth. Overnight and call money rates cooled 25bps in 4QFY25, due to aggressive open market operations carried out by the RBI.

Economic conditions

Overall FY25E GDP growth slowed down to ~6.2% as the effects of the low base of FY21 and FY22 tapered off and fiscal correction progressed further. The consensus estimates for FY26E GDP growth is slightly better at ~6.5%. Nominal GDP growth for FY25E has been materially lower at ~9.1%, and is expected to pick up to ~10.5% in FY26E.

·         CPI Inflation mostly remained within the RBI’s tolerance band of 4-6% (except for a short spike in October 2024). Core inflation eased below 4% in August and then February 2024.

·         Real rates have mostly remained in positive territory during FY24.

·         Fiscal deficit remained high despite moderation over the past few years.

·         The private sector investments failed to gather the desired pace, despite several government incentives. The government capex also slowed down in FY25. 9MFY25 investment to GDP ratio dropped to 32.6%. Private consumption recovered in FY25E from the sharp dip in FY24.

·         External conditions worsened during FY25. Merchandise trade balance deteriorated to USD292bn. Exports were lower yoy, while imports were higher by 6% yoy. External debt was higher by 10%. Net FDI flows continued to slow for the third consecutive year.

Commodities

FY25 was a mixed year for commodities. Precious metals (Gold +40%, Silver 39%) and Industrial metals (Zinc +17%, Copper +10%) recorded good gains, while energy (Brent Crude -17%, Coal -20%) and agri commodities (Wheat -16%, Soy -14%) ended the year with strong losses.

Crypto shine

Cryptocurrencies further strengthened their position with material rise in trading volumes and market capitalization. Bitcoin ended the year FY25 with a strong 21% yoy gain. More jurisdiction accepted cryptocurrencies as a valid medium of exchange, financial asset and/or tradeable asset.

Noting the economic conditions, especially still elevated inflationary expectations and resilient growth, the Fed indicated that 2025 may see fewer cuts than the previously estimated number. “With today’s action, we have lowered our policy rate by a full percentage point from its peak, and our policy stance is now significantly less restrictive,” Chair Jerome Powell said at his post-meeting news conference. “We can therefore be more cautious as we consider further adjustments to our policy rate.”

The FOMC raised its projection for full-year 2024 GDP growth to 2.5%, from 2% in September. However, in the following years, the FOMC officials expect GDP to slow down to its long-term projection of 1.8%. The committee lowered its expected unemployment rate in 2024 to 4.2%, while headline and core inflation were pushed higher to 2.4% and 2.8% respectively, slightly higher than the September estimate and above the Fed’s 2% goal.

The resilient growth and elevated inflationary expectations would require the Fed to hike or hold rates in 2025. However, officials appear wary of keeping rates too high and risking an unnecessary slowdown in the economy.

Insofar as the Trump 2.0 policies and their impact on the growth are concerned, the Fed Chairman Jerome Powell prefers a wait and watch approach. IN the post FOMC meet press interaction he said, “We’re just not at that stage.” He further added, “We need to take our time, not rush and make a very careful assessment, but only when we’ve actually seen what the policies are and how they’ve been implemented.”

The financial markets reacted negatively to the FOMC decision. Dow Jones lost 1123 (2.58%). Falling for the tenth consecutive day, it has recorded its worst losing streak since an 11-day slide in 1974. The S&P500 (-2.95%) and Nasdaq Composite (-3.56%) fell even more. The benchmark 10-year treasury yields jumped 3.08% to 4.52%, the highest level since April 2024 and 90bps higher than their August 2024 lows. UST Index rose 1.2% to its highest level in almost three years. Gold prices fell 2.3%, taking the yellow metal below US$2600 level after 3 months.

Lower duty on gold, wider trust deficit

In her final budget for FY25 (presented in July 2024), the finance minister had cut the import duty on gold from 15% to 6%. No clarity was provided for this measure in the budget papers. It is widely speculated that the move was to help the RBI in augmenting its gold reserves and bring back its gold stock held with foreign custodians; and also lower the domestic gold prices to help the government to redeem the sovereign gold bonds at a lower price.

The move has resulted in higher consumer demand for gold, resulting in larger quantities of gold import having adverse impact on the current account balance. This is prima facie contrary to the intent of the government to encourage household savings to move away from physical assets like gold towards financial assets; and maintain a healthy current account balance to support INR and bond yields. The move dented the credibility of the government and widened the trust deficit a little more.

Cooking oil makes the path slippery

Just before the festival season began in India, the government raised import duty on edible oils in September. The duty on import of crude soybean oil, crude palm oil and crude sunflower oil to 20% from zero percent previously. The import duty on refined palm oils, refined sunflower oils and refined soybean oils was increased to 32.5% from 12.5% previously. The stated objective is to provide remunerative prices to the local producers. Much of this duty hike is likely to be passed on to the consumers in due course.

This move appears totally ad hoc - to lead the market prices for edible oil (hence oilseeds) higher than the MSP to lessen the burden on the government. Given the erratic weather seen in most of the country in the past 3-4 years, it is highly unlikely that many farmers could be motivated enough to sow a fragile oilseed crop.

Most experiments with palm farming in the country have yielded sub-optimal results anyways. This move is likely to result in (i) higher and sticky food inflation burdening the already stressed consumers; (ii) stronger motivation for adulteration in edible oil; and (iii) higher working capital requirement and lower margins for edible oil producers.

The better course would have been to help the farmers partner with local manufacturers, provide financial, technology and input support (like green revolution), achieve higher oilseed production on a sustainable basis and make the imports redundant.

CGDs – pushing the chicks out of nest

The government has cut allocation of cheap APM (administered price mechanism) gas supply to the city gas distributors (CGDs), which sell CNG as alternative vehicle fuel and PNG as alternative cooking fuel. The allocation has been by ~40% in two tranches in October and November 2024. Though it is early to assess the entire impact, it is broadly estimated that these cuts are likely to result in ~40% of cheap USD 6.5/mmbtu APM gas being replaced with expensive gas costing USD10-14/mmbtu. Much of this higher cost is expected to be borne by CGDs, while some of it may be passed on to the consumers.

This reduction in the level of protection to the CGDs could be seen as a precursor to the complete privatization of the city gas distribution business. The existing CGD firms are mostly in the public sector. These may either be privatized and made to compete with the private sector without any protection.

It would be interesting to see whether (i) gas distribution business follows the trajectory of telecom, where the consumer emerged a clear winner and multiple operators (including state owned MTNL and BSNL) went bankrupt; or (ii) a private sector oligopoly emerges which would squeeze customers to maximize profits.

Regardless, in the short term we may see some trouble for CNG/PNG customers. The queues at CNG pumps may become longer, and expansion of piped gas to households may slowdown. This is definitely not congruent with the dire need for a cleaner fuel to check severe levels of air pollution in many cities.

I had posted my first impression of the Union Budget FY25 on Tuesday. On a second reading of the budget documents and listening to the views of a variety of experts, I have gathered some more inputs that I would like to share with the readers.

Impact of capital gain tax changes on equity markets

The long-term capital gain tax (LTCG) on sale of listed shares has been increased from 10% to 12.5% and the short-term capital gain tax (STCG) has been increased from 15% to 20%. The market reacted negatively to the announcement initially. However, all the losses were recouped within an hour. This has surprised many market participants who believed that any hike in capital gain tax would be detrimental for the markets.

My thoughts on this are as follows:

(a)   Tax is a function of actual profit gained or loss incurred by an investor. Stock price of a stock is a function of the demand and supply of such stock at a given point in time. Demand and supply in turn are determined by the future price expectations. If a larger number of buyers expect the stock price to rise in future, the demand will stay higher, and vice versa. Thus, if the "return expectations" of investors stay high, stock prices may not correct regardless of the cost of transaction and/or taxation of gains. The market correction may need a bigger reset for a meaningful correction. Tax or STT alone would not do much.

(b)   The capital gain tax structure has not only been simplified, on an average, the effective rates of taxation may be actually lower for many investors. For example, tax rates for STCG on listed bonds, Equity FoF, Gold/Silver ETF, have been reduced and holding periods are also aligned with listed shares. Similarly, tax rates for LTCG on Equity FoF, Overseas FoF, Gold/Silver FoF, Gold Funds, physical gold, unlisted stocks and foreign equity have been materially reduced.

(c)   Contrary to first impression, the budget may be positive for the real estate sector. The effective LTCG on sale of properties may be lower, despite lack of indexation benefit, in a majority of cases. Besides, the likely reduction in stamp duty may benefit the buyers.

(d)   By bringing taxation of listed bonds at par with equities, while keeping bond funds taxable at a much higher rate, the government wants to kick start the growth of the retail debt market, especially after inclusion of Indian government bonds in the JP Morgan bond index.

Gold

The finance minister has cut effective import duty on gold from 15% to 6% in this budget. Besides, the capital gains tax on physical gold, gold funds and gold/silver ETFs has been reduced materially.

These proposals have baffled my market participants. They have argued that this may lead to undue rise in import of gold, this adversely affecting the trade balance. Secondly, bringing LTCG taxation of gold at par with equities and bonds is against the spirit of financialization of domestic savings. It is pertinent to note that the NDA government has strived to financialize gold holdings through Sovereign Gold Bonds and other measures in the past 8 years.

In my view, there could be three reasons behind the proposal to cut tax and duties on gold.

(a)   RBI has been the largest importer of gold in India for the past couple of years. It is likely that RBI wants to further enhance its gold holdings, like the central banks of China and Russia, amidst rising global uncertainties over USD supremacy. Lower duties may help RBI to import gold cheaper.

(b)   The first series of SGBs is coming up for redemption next month. The government wants to redeem these bonds at a 9-10% lower price.

(c)   The policy makers have recently raised the issue of “excessive financialization” of the Indian economy. For example, the latest Economic Survey highlighted, “the financial sector should expand at a pace that is in lockstep with economic growth. In particular, India can ill-afford the economy's over-financing at its current development stage.” Cheaper gold prices may be an effort to set the clock back.

STT

The budget proposes to increase the securities transaction tax on sale of an option in securities from 0.0625% to 0.1% of the option premium, and on sale of futures in securities from 0.0125 per cent to 0.02 per cent of the price at which such “futures” are traded. This is an effective hike of 60%.

This is obviously supposed to act as a deterrent to excessive speculation in derivative trades by retail investors. The finance minister, the SEBI Chairperson and other policymakers have categorically expressed their displeasure over the rising retail participation in the derivative trading.

It is pertinent to note that as per a study conducted by NSE/SEBI over 90% retail traders lose money in their derivative trades.

It is interesting to note that the finance minister has assumed a ~16% rise in STT collection in her budget calculations. This implies that the government does not believe any material reduction in trading volumes at stock exchanges.

Besides, the hike in STT may not serve its stated purpose, as the retail traders treat option trades as lottery tickets. A small absolute hike in transaction cost may not deter them from trying their luck. It is the high frequency traders (HFT or Algo driven traders) who will be affected the most. If this affects their volumes, it may actually have detrimental impact on the entire market. For example, some of the HFTs may shift their base to overseas; the liquidity may diminish materially affecting the returns on arbitrage funds and hedging function.