It will certainly give a positive boost to investor sentiment , writes Mukarram Bhagat
The finance minister, P Chidambaram, has certainly kept the punishment meted out to his last Budget by the capital markets in mind while formulating his new Budget proposals for 1997-98. He has addressed all the three major issues concerning the revival of stock markets: tax incentives, opening up of new/additional liquidity inflows and a positive boost to sentiment.
The reduction of the marginal corporate tax rate to 35 per cent and the simultaneous abolition of the 7.5 per cent surcharge implies significant tax cuts of up to 8 per cent for tax paying companies, or up to 14 per cent increase in the EPS (earnings per share), assuming zero dividend. The conversion of the minimum alternate tax (MAT) into a minimum advance tax, by allowing it to be credited against the future tax payments, will benefit zero tax companies too. This will mainly benefit large, capital-intensive commodity players and the finance companies, though in the medium term. But there will be an immediate benefit too arising from the corporate tax cuts which will reduce MAT outgo to 10.5 per cent from the earlier 12.9 per cent.
Full marks to the minister for converting, and not abolishing MAT. While reducing its rigour in this manner, he has still continued with the message that tax, like pain, is a fact of life and that companies should be more preoccupied in increasing their return on assets rather than creating assets to save tax. The stockmarkets, in any case, are not very impressed by zero tax companies when it comes to share valuations the PE ratios of zero tax companies are typically much lower than those of full tax paying companies.
The abolition of tax on dividends in the hands of shareholders seems to be designed more as a sentiment booster. The anomaly of double taxation has not really been removed but simply passed on to the dividend paying company in the form of the 10 per cent levy on distributed profits. The ministers justification that he wants to encourage profit retention for asset formation is hardly credible. This levy will reduce the effective benefit of the other corporate tax reductions, particularly to the high tax and high dividend paying companies. But together with the new MAT, it will punish the zero tax companies with high dividend payouts. This will hopefully encourage them to reduce the dividend rate and send out more realistic signals to investors of their pre-tax profitability!
The removal of the anomaly in capital gains tax between FIIs (which pay 10 per cent) and NRIs (who pay 20 per cent) to a uniform 10 per cent, was long overdue. But the rate should have been reduced for resident Indian citizens too, perhaps to 15 per cent, with the 5 per cent differential reflecting a forex premium. This modest measure could have given a further boost to investor sentiment.
The proposal to allow companies to raise FII holdings from 24 to 30 per cent (both excluding GDR holdings), provided their boards and shareholders approve it, is an excellent move to further increase these inflows into the markets. It is also timely in that many big FIIs genuinely face a shortage of good quality Indian shares to invest their monies in, with many such companies having exhausted the 24 per cent cap. Again, the minister should have gone a step further and relaxed the caps on FII holdings in banks too which are currently quite restrictive at 20 per cent including GDR holdings. Every 1 per cent relaxation in the limit could rake in Rs 150 crore of FII money in SBI alone at a market price of Rs 300 per share.
The clear statement that buyback of shares by companies will be allowed in the forthcoming Companies Act Amendment Bill will also boost market sentiment even though no details of this proposal have been revealed. Buyback by companies of their own shares will open up a new source of liquidity corporate funds for the equity markets. It will also be timely in that many Indian managements are insecure about retaining control over their companies with the post-reforms entry of foreign investors with deep pockets and a liberalised takeover code. It is to be hoped, however, that the company affairs department gets the fine print right.
The one-time exemption from capital gains tax for stockbrokers wishing to corporatise will give a much needed relief to the broking community reeling under the dual impact of a domestic investment depression and competition from well capitalised institutional brokers (foreign and Indian).
Significant tariff, excise and income tax reductions will substantially benefit the middle class. At the same time, an effort has been made to cast the tax net wide. Corporates though may feel concerned about the governments unfailing resolve to reduce tariffs despite the difficult market conditions demand recession and severe competition in several industries.
Keeping the fiscal deficit at the budgeted 5 per cent of GDP, and fixing next years target at 4.5 per cent, is a remarkable achievement (assuming there is no arithmetical jugglery here!). The abolition of ad hoc Treasury bills reinforces the governments resolve to curb monetisation of the deficit and inflation. The decision to work out a gameplan and a time-table for capital account convertibility sends a powerful signal to the international investment community of Indias resolve to continue reforms and integrate with the global economy.
A major negative is the inability of the finance minister to make a breakthrough in opening up the insurance sector, so vital to funding infrastructure. A tiny beginning though has been made in opening up only health insurance and pension funds to greater local competition. Similarly, there is no major initiative or thinking indicated in removing the regulatory and other cobwebs that surround key infrastructure sectors like power (which was the major concern area of the Economic Survey), telecom or roads. It is to be hoped that major policy initiatives, with the participation of state governments, are taken soon to boost private investment in infrastructure which is now a hard constraint to sustaining the 7 per cent GDP growth. The Budgets complete silence on the alarming oil pool deficit situation and the need to decontrol oil prices is understandable on political grounds. After all, the UF government wants to ensure safe passage of its second Budget on the floor of Parliament. But oil decontrol is very
likely thereafter (sometime in May), and given the positive reform tenor of the Budget, one can give the benefit of the doubt to the government.
In sum, this is a landmark Budget that has been carefully thought through. It will certainly give a positive boost to investor sentiment which is badly needed to jump-start the stockmarkets. For, despite all the anxiety over political uncertainty and economic slowdown, the stockmarkets anywhere in the world are primarily driven by the liquidity (money supply and interest rates) and valuation (PE ratios and EPS growth) arithmetic, which is very favourable in India today. All that was needed was a positive sentiment boost, and I think Mr Chidambaram has provided that.
(The author is head of research, Birla Marlin Securities, Mumbai)
