COMMENT: 3 facts that Modi should note before commenting on markets

Shishir AsthanaMoneycontrol Research

A weekend statement from Prime Minister Narendra Modi that those who profited from financial markets had to make a contribution to nation-building through taxes had the expected impact on stock markets on Monday – they didn’t like it.

Traders could be forgiven for assuming that the statement meant an increase on taxes on financial market transactions, one way or the other. Finance Minister Arun Jaitley was quick to clarify that his boss’ statement did not suggest a tinkering with long-term capital gains tax (LTCG) but unease abounded.

As far as equity markets are concerned, government has three ways to increase takes on participants. LTCG is the lowest-hanging fruit for the government to pluck because, presently, no taxes are imposed on listed equities that are held for more than one year.

The second way is by increasing short-term capital gains tax for equity holdings of less than one year. Presently government taxes are at 15 percent.

Finally, securities transaction tax (STT) which is imposed on all buying and selling irrespective of profit or loss, can be increased. STT rates vary between 0.017 percent and 0.125 percent.

Jaitley’s clarification led people to conclude that the government might realign the definition of ‘long term’ between listed and unlisted companies. In the previous Budget, duration for investments in unlisted companies eligible for LTCG was increased to two years.  The belief in the market is that ‘long term’ for investment in equity markets could be increased from one year to two years.

FIIs had, in their representation to the government, demanded that short term capital gains be scrapped and STT be increased. Passing on the impact of short-term capital gains tax to clients is a tedious task, while STT can be built into the transaction cost.

But increasing STT is something that will severely affect short-term traders. A study done by NSE found out that India is already the costliest place to trade on account of STT and various other taxes. Most of the volume on exchanges across the world is on account of arbitrage and algorithm trades or programme trades. Increasing STT would impact liquidity in the markets and affect money flows from both domestic and foreign players.

None of the steps above helps markets in any way, and expect shares to be under pressure until the Budget.

The entire incident brings out three points.

First, the PM should be more careful with market-sensitive statements. He should know that financial markets run on investments made largely from savings, made after paying all the taxes by the investors. Some retail investors use it as a vehicle to avail tax exemption. A buoyant financial market built through savings helps in the process of nation building.

A committee set up by the government on GAAR headed by Parthasarathi Shome in 2012 said that the revenue collected by way of capital gains taxation is very small compared to the overall direct taxes collection. The committee suggested that abolishing the tax on short term capital gains may provide a boost to capital markets and in turn help attracting investments.

The second point is the irresponsible attitude of the government towards taxes. If there is one word that any investor fears, it is taxes. On the issue of minimum alternate tax (MAT) Jaitley had in 2015 said that India is not a tax haven to FIIs and what is due must be paid. This was said after the FM had exempted FIIs from MAT. The FM’s aggressive stance did not go well with FIIs in fact it scared them away. In an embarrassing turn of events for the government the Supreme Court judgment on Castleton Investments, relating to the same issue, went in favour of the FIIs, thus settling the issue.

The third point is that the government seems to be oblivious to the fact that it is competing with other countries to attract foreign capital. On the one hand PM Modi goes to every country asking for investments; on the other, his government suddenly changes the rules of the game. Any investor would need clarity on taxes to plan their savings. An arrogant government, irrespective of the reforms it brings, is not something that investors like.