Valuation, capital gains tax treatment key risks for the market: Analysts

After a sharp rally in the Indian markets from their June 2022 low, risks are now emerging in the form of high valuations, moderation in growth amid recession across major economies, said analysts. However, they believe the Indian markets will be able to tide over this uncertain short-term phase amid volatility.

From their June 2022 lows, the S&P BSE Sensex and the Nifty 50 have gained around 18 per cent each and have outperformed their global peers by a wide margin. A significant rally seen since then on renewed foreign investor participation and a resilient domestic macroeconomic situation, according to analysts at BNP Paribas, has led Nifty 50 valuation to expand again to around 19.7x, which is 22 per cent above its long-term average.

"The bond earnings-yield gap has widened to -2.4 per cent, which is around 120 bps below its average of -1.2 per cent since 2009. Historically, at this level of gap, we have seen negative one-year forward returns. For the Nifty 50, we see a lack of positive catalysts for any meaningful consensus (earnings) estimate upgrades, with risks skewed toward the downside on a sharper-than-expected global slowdown and inflation remaining stable at high levels," said Kunal Vora, head of India equity research at BNP Paribas Securities India.

Meanwhile, the Indian economy as measured by the gross domestic product (GDP), according to analysts at Goldman Sachs, is likely to slow to 5.9 per cent in 2023 as compared to 6.9 per cent in 2022. Growth, the believe, will likely be a tale of two halves, with a slower first half as the reopening boost fades, and monetary tightening weighs on domestic demand.

"In the second half (of 2023), growth is likely to re-accelerate as global growth recovers, drag from net exports diminishes, and investment cycle picks up. We forecast headline CPI inflation to decrease to 6.1 per cent (average) in 2023 from an estimated 6.8 per cent in 2022, as food prices remain contained," wrote Andrew Tilton, chief Asia-Pacific economist and head of EM economic research at Goldman Sachs in a recent coauthored note with Santanu Sengupta and Deepak Narendranath.

Capital gains tax

Another unknown risk that the markets are not pricing in at the current levels is the possibility of a change, if any, in the treatment of the current capital gains tax structure in the budget in February 2023.

The government, reports suggest, may rationalise long-term capital gains tax (LTCG) structure by bringing parity between similar asset classes. That apart, revising the base year for computing indexation benefit could also be on the anvil.

"Some investors seem worried about potential tax levies or an increase in LTCG rates, in case targeted consumption subsidies to the poorer sections are provided as the general elections of 2024 draw near. Additional tax surcharges or a possible hike in the Long-term Capital Gains (LTCG) tax could dent investment sentiment considerably," said Manishi Raychaudhuri, Asia Pacific Equity Strategist at BNP Paribas.

Currently, shares and equity-linked mutual funds held for over one year attract long-term capital gains tax of 10 per cent on gains exceeding Rs 1 lakh. Sale of shares with holding period of less than a year are classified as short-term gains (STCG) and attract a tax of 15 per cent.

"The holding period may increase from one year to two years. That's good in a way as people will hold on to their stocks/investment for a longer period. We still do not know if the LTCG and STCG rates will be brought at parity. That said, there will be some differentiation between these two. Whenever a new tax structure is introduced, there is bound to be some nervousness and a knee-jerk reaction. The markets, however, eventually come around," said Deven Choksey, managing director at K R Choksey.