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India Budget FY17 - An Investor's Prelude

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Budget - A marketing event, no less, no more
Although, the attention that is paid to the annual budget speech has diminished in past decade or so, it still evokes intense interest from the financial market participants. I feel it has more to do with the marketing success of business news channels rather than anything else. A number of TV shows are hosted to propagate an environment of expectation, hope and fear amongst market participants.
Somebody gotta give
Last evening I heard some bankers and economists at a seminar. The common running idea in all formal presentations was how to revive investments without compromising fiscal discipline. But none, yes none, suggested higher taxation on businesses or the rich.
Market low on hope this time
This year heading into the budget presentations, the markets are badly beaten, extremely jittery and expecting little from FM. Save some minor tax concessions here and there, the market is mostly praying for a status quo.
Reforms go much beyond New ITR forms
I have been insisting that "reform" must be distinguished from mere administrative correction. A policy measure in order to qualify as "Reform" must change the status quo materially.
Reform do not mean higher profit or higher Sensex
The businesses, investors and consumers need to assimilate that economic reforms do not necessarily result in more profit in the immediate term. To the contrary, economic reforms are more likely to cause pain and inconvenience in the immediate term as these involve fundamental changes in the processes and practices of doing business and consuming goods & services.

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India Budget FY17 - An Investor's Prelude

  1. 1. Union Budget 2016-2017 An investor's prelude Friday, 26 February 2016 Opinion InvesTrekk reports are purely based on social, macroeconomic and technical studies. These should not be read as equity research reports. We do not provide portfolio management, stock broking, investment advisory, equity research or any other fund based service. This report is not intended to provide investment advice or research and it does not take into account the specific investment objectives, financial situation and the particular needs of any specific person. Readers should seek financial advice regarding the appropriateness of investing in financial instruments and implementing investment strategies. The views expressed in this report are personal views of the author. InvesTrekk Global Research (P) Limited shall not be responsible in any manner for any loss or damage caused to anyone acting on the basis of the views expressed in this report. Please refer to the important disclosures at the end of this report. © Copyright 2015 InvesTrekk Global Research (P) Limited. All rights reserved. InvesTrekk – Trekking the path less travelled and InvesTrekk are trademarks of InvesTrekk Global Research (P) Limited. Budget - A marketing event, no less, no more Although, the attention that is paid to the annual budget speech has diminished in past decade or so, it still evokes intense interest from the financial market participants. I feel it has more to do with the marketing success of business news channels rather than anything else. A number of TV shows are hosted to propagate an environment of expectation, hope and fear amongst market participants. Somebody gotta give Last evening I heard some bankers and economists at a seminar. The common running idea in all formal presentations was how to revive investments without compromising fiscal discipline. But none, yes none, suggested higher taxation on businesses or the rich. Market low on hope this time This year heading into the budget presentations, the markets are badly beaten, extremely jittery and expecting little from FM. Save some minor tax concessions here and there, the market is mostly praying for a status quo. Reforms go much beyond New ITR forms I have been insisting that "reform" must be distinguished from mere administrative correction. A policy measure in order to qualify as "Reform" must change the status quo materially. Reform do not mean higher profit or higher Sensex The businesses, investors and consumers need to assimilate that economic reforms do not necessarily result in more profit in the immediate term. To the contrary, economic reforms are more likely to cause pain and inconvenience in the immediate term as these involve fundamental changes in the processes and practices of doing business and consuming goods & services. NITI Ayog needs to tell the government that in past one decade it is not the farming, textile, railways, or SME but it is the telecom sector which has provided maximum incremental employment opportunities. And it all has happened in spite of the government. No Research. No Advice. We simply state what we see while exploring the vast treasure, you know as India. Vijay Kumar Gaba Team InvesTrekk investrekk@gmail.com (For private circulation only)
  2. 2. 26 February 2016 2 Union Budget - A marketing event, no less, no more The finance minister is like CFO of a business corporation. His job is to keep account of the receipts and expenditure of the government; manage resources necessary for executing the plans approved by the Cabinet; ensure optimum utilization of available resources; and keep adequate provision for meeting contingencies. He is accountable to all the stakeholders, insofar as the transparency of accounts is concerned. His discretions are however limited to choosing the sources of revenue needed for executing the plans of the government. In specific Indian context, FM has to decide how much resources to raise from (a) taxation; (b) sale of national assets; and (c) borrowing. In taxation, a balance has to be maintained between direct and indirect taxes to keep the incidence of tax just and equitable. Sale of national assets (mines, airwaves, PSE shares, land etc.) has to meet the criteria of sustainability, development, transparency, viability, socio- political expediency; etc. and depends heavily on the current market conditions. Borrowing depends on consideration of fiscal discipline, servicing capacity, and market conditions. Historically, we have borrowed from domestic lenders only. However, in recent years the role of foreign lenders has been rising; the exchange rate volatility has therefore become a consideration. The FRBM Act also guides the extend of borrowing. The importance, or otherwise, of the annual budget presentation must be seen within this framework. Although, the attention that is paid to the annual budget speech has diminished in past decade or so, it still evokes intense interest from the financial market participants. I feel it has more to do with the marketing success of business news channels rather than anything else. A number of TV shows are hosted to propagate an environment of expectation, hope and fear amongst market participants. The anticipation, that is sometimes far beyond the realm of reality, guides the market volatility. The representatives of various interest groups and lobbyists for pressure groups demand from FM, what he has no jurisdiction to give. For example, someone asks FM to allocate more money for infrastructure spending. Whereas, this request should logically be made to the concerned ministry and departments, which shall make a plan, and get approved by the cabinet. FM will be obliged to provide resources for a plan approved by the cabinet. A defiance could see him losing his job. I believe that it is high time that the development agenda of the government be completely separated from the budget presentation. Let budget be an accounting exercise with a reasonable degree of predictability and transparency. Let public appraisal of the development agenda be a continuous process through regular reporting by the concerned departments and ministries.
  3. 3. 26 February 2016 3 Somebody gotta give Once there was this person who lived his life in complete dissoluteness. He loved to eat out, smoke, drink, often enjoyed late night parties and spent profusely. All was going on well, till the day his heart gave him first shock. The life suddenly changed. The sight of death triggered the transformation. Morning walk, yoga, healthy meals, early to bed and timely medicine were his life now. Somewhat similar is the situation of many Indian corporates and banks today. The profligate capex funded by indulgent borrowing by the businesses in past 15years has severely damaged their balance sheets. Unable to bear it, most have conveniently passed the pain over to lenders. The promoters are naturally worried that a close scrutiny by Supreme Court and RBI may set the course right by holding them accountable for their accesses. The markets which have cherished every bit of their profligacy in the past are also naturally worried. The government is seeking to structurally reverse the persistently negative interest rate on financial savings which in past decade have discouraged household savings, the very backbone of our economic growth. The tax incentive on savings has also become a totally ineffective tool in the current inflationary scenario. A reform here – to fix the savings rate at CPI plus one percent would make many businesses unviable. The family businesses which have long thrived on subsidized capital from banks and financial institutions shall have to dilute their equity, should they be forced to borrow at competitive terms. Do they really want it? Similar is the case with labor reforms, tax reforms, etc. Not many businesses seem to be welcoming lower tax rate with rationalized exemption regime. Zero tax on long term capital gains on listed equities is another bone of contention. The mere hint of withdrawal of this exemption has made markets jittery. But to develop a vibrant debt market an encouraging start ups, brining parity in taxation of debt instruments, unlisted equity and listed equity might become necessary. ...but not me Last evening I heard some bankers and economists at a seminar. The common running idea in all formal presentations was how to revive investments without compromising fiscal discipline. But none, yes none, suggested higher taxation on businesses or the rich. Many wanted tax sops to encourage private sector investment and higher protection to the globally uncompetitive industries facing challenges from cheaper imports. But no one explained that how businesses will be motivated to invest in new projects when the economy wide capacity utilization is at cycle lows and export demand is clouded!
  4. 4. 26 February 2016 4 Market low on hope this time On February 28, 2015 Shri Arun Jaitely presented his first full budget amidst great expectations. The market which was already on roll for past many months, scaled new high within three trading sessions after presentation of the budget. However, since then it has been a rather disappointing journey downhill. ...bruised and jittery This year heading into the budget presentations, the markets are badly beaten, extremely jittery and expecting little from FM. Save some minor tax concessions here and there, the market is mostly praying for a status quo. ...praying for status quo Given the constraints like: (a) the substantial pay commission and OROP payments already overdue; (b) disinvestment targets already scaled down due to poor market conditions; (c) commitment to implement food security law in FY17; (d) RBI Governor's and global rating agencies' strong urge to not compromise on fiscal discipline; (e) lower nominal economic growth leading to muted tax revenue growth; (f) political urgency to provide for social spending in view of the key state elections due in FY17 (TN, Kerala, WB, UP and Punjab) - expecting any radical proposals from FM in the budget seems unrealistic to me. I believe, the market fully understand the dilemma of the finance minister and hence does not expect him to dole out any goodies from his hat. Save for the customary pre-budget memorandums by the trade and industry representatives, I do not see any pressure on FM from the market side. ...conjuring up fears which FM can easily allay by inaction To the contrary, to keep the spirit of its participants alive, the market has itself conjured up some events - not happening of which will make people relieved; return of long term capital gain tax on listed equities being the most prominent one. Having observed the working of the finance ministry closely in past 21months, I am reasonably assured that both the finance minister are exceedingly sensitive to the financial markets. At this juncture, I do not expect them to do anything that will trigger a sell-off in the market. .
  5. 5. 26 February 2016 5 LTCG an anomaly, may need to be corrected, sooner than later Having said that, I think that exemption to the listed equities from LTCG (provided STT has been paid on the sell trade) is an anomaly that would need to be corrected at some point in time, sooner than later. Tax break on LTCG defy logic Evaluating holistically, the activity of buying and selling equity shares in secondary market per se does not provide any risk capital to the underlying businesses. It in effect just changes the beneficial owner of the business. Prima facie it sounds illogical why should someone who is actually transferring his risk, be rewarded with lower (or no) taxes? ...argument in favor weak It is extremely difficult to support the argument that holding a listed stock for more than one year in any way helps the economy or the markets. The logic of holding a security for longer term, if at all, enhances the chances of higher returns for the investor. Why should the investor be given tax breaks for enhancing his return prospects? One could appreciate the "development of capital market" argument in case of investing in IPOs, PE funds, or venture funds etc., as in such cases the businesses get the much needed risk capital. But the secondary market transactions do not pass this muster. The incentive for longer term holding period has, in my view, failed miserably in improving market liquidity or minimizing market volatility. ...has been "misused" more than "used" It is common knowledge in market place that the LTCG exemption for tax has been abundantly misused for money laundering purposes. In fact last year, the regulator and taxation authorities have also initiated action in many cases for misuse of LTCG taxation provision for money laundering. Day traders, jobbers and unsecured creditors deserve it more In fact, to the contrary, the day traders, jobbers and market makers who provide the much needed liquidity to our shallow markets, and hence motivate risk taking, deserve serious tax incentives. Abolition of Securities Transaction Tax (STT) may actually lead to material rise in daily volumes and deeper markets, thereby materially lowering the transaction cost. Similarly, providers of unsecured debt take much higher risk and therefore deserve more tax incentives. In absence of a functional retail debt market, companies depend heavily on "fixed deposits" from household investors for meeting their working capital requirements. These deposits are fully unsecured and entail high risk for investors, in lieu of marginally higher interest rates as compared to bank lending rates.
  6. 6. 26 February 2016 6 Reforms go much beyond New ITR forms I have been insisting that "reform" must be distinguished from mere administrative correction. A policy measure in order to qualify as "Reform" must change the status quo materially. Reform do not mean higher profit or higher Sensex The businesses, investors and consumers need to assimilate that economic reforms do not necessarily result in more profit in the immediate term. To the contrary, economic reforms are more likely to cause pain and inconvenience in the immediate term as these involve fundamental changes in the processes and practices of doing business and consuming goods & services. Reforms must change status quo materially From this view point, I suggest the following 10 illustrative reform measure that may change the status quo materially. If you find these are highly idealistic, and impractical to implement, I beg to differ. (1) To exploit the demographic dividend fully and generate demand, accelerate the wealth transfer process. Defining the upper bound of wealth and introduction of material estate duty on people above the upper bound could be one method. (2) Transfer the power to impose direct taxes, to the local governments. (3) Transfer the ownership of natural resources to local governments. Encourage industry and investors to partner with local governments for setting up business ventures. (4) Introduce competition in Railways. To begin with allow point-to-point private railways for intercity travel up to 100kms. (5) Transfer all PSUs under a listed holding company. Majority voting power in this listed holding company may be owned by Indian citizens with no individual owning more than 1%. All these companies should be professionally managed with no intervention from the government whatsoever. (6) Allow and encourage the federal states to have bi-lateral trade, labor and resource (water, energy, logistics etc) sharing treaties. (7) Bring the Return on Investment (ROI) for elected representatives close to Zero level, by stripping all their discretionary powers. (8) Constitute a Clean India Regulatory Authority (CIRA). Make all elected representatives from local government level to the members of parliament accountable to this authority. Each member should be mandated to submit a quarterly return of cleanliness in their respective constituency to this authority. The authority should cause an independent audit of such certificates. A wrong certificate should disqualify the person from contesting elections for 25years. (9) Enhance the Right to Education (RTE) to the Right to Uniform Education (RTUE). (10) Reorganize farm sector with "collective farming", "cooperative food processing" and "national market" at the core.
  7. 7. 26 February 2016 7 Important disclosures It is important to note that InvesTrekk and its employee do not offer any portfolio management , brokerage, money management, equity research or investment advisory services of any kind. Please take advise of a qualified and registered investment advisor before taking any investment decision. InvesTrekk Reports provide generalized market intelligence to its subscribers based on our social, macroeconomic and technical studies. Neither the information nor any opinion expressed constitutes an offer or an invitation to make an offer, to buy or sell any securities or other financial instrument or any derivative related to such securities or instruments (e.g., options, futures, warrants, and contracts for differences). InvesTrekk reports are not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation and the particular needs of any specific person. Investors should seek financial advice regarding the appropriateness of investing in financial instruments and implementing investment strategies discussed or recommended in the reports and should understand that statements regarding future prospects may not be realized. The reports provide general information only. Neither the information nor any opinion expressed constitutes an offer or an invitation to make an offer, to buy or sell any securities or other financial instrument or any derivative related to such securities or instruments (e.g., options, futures, warrants, and contracts for differences). The reports are not intended to provide personal investment advice and these do not take into account the specific investment objectives, financial situation and the particular needs of any specific person. Investors should seek financial advice regarding the appropriateness of investing in financial instruments and implementing investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investments in general and, derivatives, in particular, involve numerous risks, including, among others, market risk, counterparty default risk and liquidity risk. No security, financial instrument or derivative is suitable for all investors. In some cases, securities and other financial instruments may be difficult to value or sell and reliable information about the value or risks related to the security or financial instrument may be difficult to obtain. Investors should note that income from such securities and other financial instruments, if any, may fluctuate and that price or value of such securities and instruments may rise or fall and, in some cases, investors may lose their entire principal investment. 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