Vijay Kumar Gaba: LTCG

Showing posts with label LTCG. Show all posts

Tuesday, January 19, 2021

The generous uncle

One of the distinct childhood memories is about the Uncle, who used to visit foreign countries for work almost every year. After every foreign visit, he would host a family dinner. At the gathering he would explain the difference between heaven (Europe and USA) and hell (India). He would make every adult regret for taking birth in India and make every child aspire to settle abroad.

We (me and my brother) were usually not interested in what Uncle is saying. Our interest was limited to the last act – opening of goodies bag post dinner. He would very generously distribute the “gifts” he had brought from “foreign”. These gifts would invariably include – bathroom sleepers, shaving and dental kits, cosmetics and writing instruments picked from the hotel room he had stayed and flight he had travelled; bottles of perfume; some clothes; small toys; and souvenirs, mostly bought from dollar stores (this I know in hindsight after travelling myself). Three essential things were bottles of liquor bought from duty free shop, a wrist watch and some electronic gadget (camera, oven, juicer, VCR etc.). These items he would offer to sell. (In hindsight I know that he would recover the cost of his entire trip and gifts by selling these items.)

Presentation of Union budget, every year by the finance minister, always reminds me of the generous uncle. A great build up before the budget presentation; a long speech; a strong feeling of regret for being Indian middle class; distribution of some goodies for the poor; and higher taxes to meet the higher expenditure. Since the dream budgets of 1996; the same story has been repeated for past 25years. Almost every time, people end up disappointed and disillusioned after the fine print of the budget are explained to them the next morning.

Notwithstanding the outcome, the charade of pre-budget shows, writings, representations, expectations and analysis is repeated enthusiastically. Hopes are rekindled only to be shattered. This year is no different.

The grim reality of Union Budget 2021 is that the government is terribly short of resources and extraordinarily high on promise. To meet the promise, additional resources would need to be raised. The government knows it well. The businesses know it even better. Rest all (consultation with stakeholders etc.) is the Uncle’s dinner to sell the duty free liquor and gadgets.

For those who are expecting the finance minister to take out some bazooka from her tablet (this year budget is digital, hence no briefcase), I have stated this earlier also and would like to repeat:

The scope and importance of Union Budget has diminished materially over the past two decades.

· Initially the changes in tax rates were made only through the Finance Bill which is part of the budget exercise. However, many springs ago the government assumed the power to change the rates of excise etc through notification outside the budget. Subsequently, the GST subsumed most of the indirect taxes and the power to alter GST rates has been exclusively vested in the GST Council. The Union Budget has no role to play in GST rates now.

· The boundaries for rates of customs duty are now mostly set in accordance with the WTO agreements. The union government can change these rates to safeguard domestic industry from unfair pricing by overseas suppliers or to stabilize the domestic prices in times of abnormal supply shocks. These changes could be done whenever a need arises. The union budget has little role to play in this.

· Post implementation of the 14th Finance Commission recommendations, the onus to implement a large number of welfare schemes has been transferred to the respective state government.

· The petroleum products' pricing has been mostly deregulated and the budget provides no subsidies for the transportation fuel now.

· Most of the public sector enterprises, like NHAI, Railway Subsidiaries, Oil & Marketing companies now raise resources directly rather than through the budgetary support.

· The corporate tax rates were restructured materially in August 2019. It would not be reasonable to anticipate any further concessions in corporate tax.

· Higher energy and food inflation may warrant some concessions in the personal taxation, especially for the smaller tax payers. Inflation scaled increase in basic exemption limit and standard deduction may be considered. But this will be subject to resource constraints.

· The government has announced a National Infrastructure Pipeline (NIP) of Rs1.02trn in December 2019. This proposal was strengthened through various stimulus packages announced during the course of 2020. This obviously takes out almost all major projects from the union budget.

· Disinvestment of public sector undertakings a continuous process. Though a provision for receipts from this head is made in the budget, there is no evidence of any correlation with the actual disinvestment proceeds and budget provisions, in past 30yeras of disinvestment process.

· Telecom spectrum auction and bank recapitalization allocation are other two key items watched closely. Again, in past 20yrs, there is no evidence of any correlation between the actual allocation and budget provisions.

Analysis of various reports indicates that market participants may be expecting the following from Union Budget 2021:

(a) Significantly higher government expenditure, especially on infrastructure building. Setting up of a specialized development finance institution (DFI) is also one of the key expectations.

(b) Additional tax concessions to middle classes especially salaried people.

(c) Concessions for housing sector, especially higher interest rate subvention; higher cut off limit for definition of affordable housing; additional concessions for developers of affordable housing projects including extension of tax holiday beyond March 2021.

(d) Review of taxes on investment (STT, LTCG, Dividend Tax)

(e) Continued suspension of FRBM till FY24.

(d) Fresh (higher) allocation for bank recapitalization.

(e) Cut in excise duty on automobile fuel.

(f) Some progress on Bad Bank formation.

The fears of market include the usual wealth tax, estate duty, additional tax on tobacco products.

Clearly, the expectations this time are running quite low. Just for the sake of a good omen, I would also expect the following from the finance minister:

(1) Make capital gains (Long term and Short Term) tax rate uniform across all asset classes. This will allow rationalization of asset allocation process by removing tax arbitrage between asset classes.

(2) Formula to link the basic exemption with some objective criteria (e.g., inflation, per capita GDP, house price index, education and healthcare expense per household as per latest NSSO survey, etc.) This will make the taxation structure more equitable and end the need to speculate over exemption limit before every budget.

(3) Refrain from imposing additional taxes and cess to cover the cost of Covid vaccination and stimulus.

I would however be not disappointed if FM refuses to oblige me by meeting any of my expectations. I know this is an exceptional year and she has many strings to balance.

Tuesday, August 20, 2019

Suggestions for stimulating the economy

Suggestions for stimulating the economy

The number of people cautioning about a deeper and longer economic slowdown in India is rising by the hour. Tata Motor's management has guided for double digit fall in automobile sales in FY20 (see here). Most auto companies have announced shut downs; some have also announced significant reduction in the employed workforce. SBI chairman is insisting on urgent need for some stimulus in almost each of his public presentations (see here). Most other senior banks and industrialists have also sounded the caution begul (see here)

The stock markets have corrected sharply in past one year; though the benchmark indices may not be reflecting the correction as yet. The wealth erosion for investors has been material. The market participants are clamoring hard for a stimulus package to bring the economy and market back on path of high growth.

Whereas, most businessmen and market participants have echoed the demand for stimulus, I have not seen many actionable solutions being suggested. Generally the solutions suggested are limited to lending rate cut, GST rate cut, and roll back of tax provision relating to surcharge and long term capital gains.

In my view, roll back of the tax provisions relating to long term capital gains and surcharge on high income non corporate entities may not add to the economic growth in any significant measure, though it might be a short term sentiment booster.

As per the available data, SBI has already cut MCLR by about 30bps post recent repo rate cut of 35bps. Current SBI MCLR (8.25%) is now ~100bps lower than the highest rate seen in early 2016. However, the current interest rate is still 300bps higher than the lowest rates we saw in 2003. Given the persistent low inflation, low money multiplier and global strong deflationary trends, there is scope for meaningful rate cut. To be effective immediately this rate cut must have some shock value. Small doses of 10-20bps cut in lending rate may take much longer to reflect in higher demand and therefore may not qualify as "stimulus".

A material cut in GST rates for automobile etc may stimulate demand. However, the impact may be somewhat neutralized as lower GST revenue shall constrict government's spending ability. In case the government chooses the path of fiscal expansion through additional market borrowing, the private investment may get crowded out. GST rate cut therefore may not be an easy option for the government to exercise.

I believe the government needs to take these conventional stimulating measures steps in adequate quantity. However, to enhance the impact of these measures, a number of additional measure aimed at boosting sentiments and stimulating higher trade volumes and activity level would be needed simultaneously.

The following are some of the illustrative measures that could be considered by the government for immediate implementation:

(a) In most parts of the country, the Ready Reckoner or Circle Rates (minimum property rates considered for levying stamp duty) are much higher than the prevailing rates of property. The government must consider bringing this minimum threshold to 10% below the prevailing market rate to stimulate transactions in property market.

(b) Capital gains of upto Rs25lacs on all constructed properties may be exempted from income tax for two years, i.e., AY21 and AY22.

(c) Capital gains on sale of gold may be exempted, provided the entire sales proceed is invested in buying one or more constructed property (residential or commercial).

(d) Concessional Housing advance by companies to their employees in next 2years may not be treated as perquisites during the term of the advance.

(e) Trading in agri commodities may be exempted from cash transaction limits completely for 2yrs, i.e, till March 2021. Post that restrictions may be applied in graded manners over next 5yrs.

(f) GST input credit for automobile purchase may be allowed for six months, i.e., October 2019 to March 2020.

(g) Upto 50% discount may be offered on power tariffs to all green field industrial units that are approved before March 2020 and begin commercial operation before March 2022.

(h) The payment time for all government contracts and supplies may be cut to 15days from the present 60-180days. All outstanding payments to contractors and suppliers may be released immediately. The arbitration and legal awards in favor of the contractors and suppliers may be honored immediately.

(i) PSU banks may be adequately recapitalized immediately.

(j) Long term corporate bonds (10yrs or more original maturity) may be treated at par with equity for capital gains taxation purposes. Periodic Interest on such bonds may be taxed @10% without any limit.

(k) CSR spend in setting up rural schools and health centers may be made tax deductible at 125% of the amount spend. The operating and maintenance expenses on such schools and health centers may also be made tax deductible.

(l) 25% capital subsidy may be provided to agri produce processing units set up in the rural areas, provided the farmers who would supply agri produce for processing to such industrial unit form a cooperative society; and such cooperative society is allotted 25% equity in such unit free of cost. Gram Sabha land may be leased to such industrial units at nominal rent.

(m) The government may make a solemn promise that the effective rate of direct taxation for any assessee shall not rise for next 3yrs

Thursday, August 1, 2019

What's bothering Indian equities - 2

Some food for thought

"A demagogue is a person with whom we disagree as to which gang should mismanage the country."

—Don Marquis (American Poet, 1878-1937)

Word for the day

Demagogue (n)

A person, especially an orator or political leader, who gains power and popularity by arousing the emotions, passions, and prejudices of the people.

First thought this morning

Founder of Cafe Coffee Day (CCD) succumbed to the pressure and decided to take the extreme step. This is a sad moment for many like me who had a truly good time enjoying coffee with friends in CCD.

In CCD, V. G. Siddhartha (VGS) created a brilliant institution. However, somehow I am finding the obituaries, comments and reactions from media, market participants, social media stars etc quite hypocritical.

Vijay Mallya (VM), also established a brilliant institution in Kingfisher Airlines. I had really good time travelling in Kingfisher. I am sure almost everyone did. Like VSG, he also had unpaid loans worth 8000-9000crs. Both claimed to have sufficient assets to pay their loans, but faced inadequate liquidity to regularly service their loans. Both had political connections. Income Tax and Enforcement agencies alleged evasion of tax and diversion of funds in both cases. Both chose to escape the situation instead of facing it.

The only difference is that VSG could escape to land beyond reach of anyone, whereas VM is within reach.

For VSG plight, system is being blamed, whereas VM is made out to be a villain.

I feel sorry for VSG, and I have no sympathy for VM. But I would not blame the system for the plight of both. It's the greed, vanity, managerial inefficiency, inability to manage the change, and disregard for the process of law that took both of them down. And they are not alone. Many more are finding themselves in the similar situation. I hope none takes the VSG or VM route to salvation.

Chart of the day

What's bothering Indian equities - 2

I noted yesterday (see here), there is not sufficient evidence to establish beyond doubt that the regulatory changes like LTCG tax, reclassification of mutual fund schemes, higher effective rate of tax for rich and certain class of FPIs, etc may be responsible for the severe correction in the broader markets in past 18months, or the fall in benchmark indices in past 8weeks.

I may add that outcome of an election fuelling a sustainable market rally is also mostly anecdotal and not conclusive by any measure. For example, look at the following chart of Nifty. The uptrend that started with RBI's strong measures to control CAD and improve liquidity, was broken in August 2015, despite a strong government perceived to be development focused at the helm. Nifty has never been able to break out of that trend line since then. Nifty has given up the entire post 2019 election rally within one month, despite the same government returning even with a stronger mandate.

It is therefore fair to assume that the market up move that started in February 2016 is in fact a shallow bear market rally that has held up well for more than 3yrs.

In this period about one fourth of the frequently traded 1300odd stocks on NSE have lost more than 50% of their value. Another 15% of these stocks have lost anywhere between 25% and 50% of their value. About 25% of stocks have moved between (-)25% and 25%. Only less than one third of the stocks have yielded a return better than bank deposit (~7% CAGR) since February 2016.

In conventional sense, the return on the investment in publically traded equity is a function of 3 factors (a) earnings growth; (b) changes in price earnings (PE) ratio and (c) dividend.

Earnings growth is a function of multiple factors, e.g., (a) capacity (production capability); (b) demand environment (market leadership); (c) competitive landscape (pricing power, cost advantage); (d) innovation and technology advantage; (e) resource availability (raw material, labor, capital, managerial bandwidth etc.), etc.

Price Earnings Ratio (PER), one of the most popular equity valuation criteria, is the ratio between the earnings of a company and its market value. It broadly signifies that at the current rate of earnings how many years it will take for the company to add the value which an investor is paying today.

Principally, an acceptable PER for a company's stock is defined by (a) the return on equity (RoE) a company is able to generate on sustainable basis and (b) the growth rate of earnings that could be achieved on sustainable basis. A company that could generate higher RoE consistently and is likely to grow faster, should be assigned a higher PER as compared to the ones which generate lower RoE or has low or highly cyclical earnings growth.

A rise in PER, if not commensurate with the rise in earnings profile needs deeper scrutiny. Sometime the rise in PER occurs due to correction in anomalies (undervaluation) of the past. This is a welcome move. Sometime, PER changes (re-rates) due to relative forces, e.g., rise of PER in comparable foreign markets or change in return profile of alternative assets like bonds, gold, real estate etc. This is usually unsustainable and therefore a short term phenomenon. Many times, demand-supply mismatch in publically traded equities also drives re-rating of PER (excess liquidity chasing few stocks and vice versa). This is again usually a short term phenomenon.

Sustainable rise in dividend yield is generally a sign of stable profitability growth (P&L improvement) and strong financial position (B/S improvement) and stronger cash flows. In some cases however it could reflect stagnation in growth

Analyzing the present Indian market context, I find that most of the market gains in past 6years occurred due to PE expansion. The earnings growth had been anemic, and dividend yield has in fact contracted since 2013.

It highlights that 75% to 80% of the equity return in past 6 years is consequent of PE ratio expansion and only 20% to 25% is due to earnings growth. In this period Earnings have in fact grown at measly 3.7% CAGR.

As I wrote a couple of months ago also, once the market participants are through with their affair with the politics, budget, global trade war, rate cuts, need for fiscal stimulus etc, they would need to sit, put their heads together and contemplate the following:

(1) How much is the scope for further PE expansion of Indian equities?

(2) How much earnings will have to grow in next 3years to normalize the rapid PE expansion of past 6years?

(3) Is there enough visibility of earnings growth for next couple of years at least?

(4) Though the premium of midcap to the benchmark indices has moderated considerably in past one year or so, but does absolute valuations are attractive enough to provide decent returns over next 3-4years?

(5) Is it reasonable to assume that due to higher domestic inflows into equities, we might not see any dramatic price correction, nonetheless a prolonged time correction cannot be ruled out?

Answer to these inquisitions would guide how much return one should be expecting from Indian equities in next couple of years.

Given the turmoil in corporate debt market and moderate gilt yields, on risk weighted basis the overweight equities strategy will still make more sense than a balanced asset allocation in my view. However, the return expectations may need material moderation.

Besides the fundamental issue of earnings and overvaluations, there are some market related issues that are of major immediate concern to the market participants. I would like to highlight these issues also, in my next post.