Perfect Timing

Notwithstanding the logic of parity in tax structure across various investment avenues, introducing a 10% tax on long-term capital gains is a super smart move by the Finance Minister. And any worries that the money will flow out of equity markets because of this tax burden seems pointless given the investment scene in the country today.

If flows into equities have been good in the past year, it is because individual investors are, finally, seeing equities as a viable alternative. The buoyancy in the market and the Rs.183,000 crore flow into mutual funds is mainly due to the dearth of credible alternatives to stash savings.

Real estate, a preferred investment for rich Indians, and also an avenue to deploy black money, is no longer the hiding ground it used to be, thanks to the clamour for transparency with RERA coming in. Not that the return was looking fancy either. Property prices have been stagnant or correcting for the past couple of years now, yet they seem out of whack. Whether you benchmark against other parts of the world or against the affordability criteria within India, no one can convincingly make an argument for steady capital appreciation from these levels. Yields are dismal at less than 2%.

That makes fixed income look a lot better, but for the inflationary overhang. Tax-free bonds, yielding 6%, covers inflation at the moment, but there is no guarantee that’ll be the case going ahead. There have been long periods of negative real rates in India, but the fear phychosis associated with the stock market kept investors stuck to this safer alternative. So, the only way to ensure a return consistently above inflation is to stomach the risk and invest in equities. Given the reality that money will come into equities, there is no reason for the government to forgo a potentially large tax kitty.

The market, of course, is glad that the tax will be applicable only on gains hereafter, and not on gains accrued thus far. The question is the potential for substantial gains from here on. Equities, helped by global liquidity and momentum, are at elevated levels, with a bleak chance of super-normal gains. But that hardly determines flows into the market in the short term.

In reality, the irony with equities is that there is greater demand at higher prices. When sentiment is good, damn the valuations — and the tax. The FM’s decision to cash in on this huge potential tax collection must be complimented for its impeccable timing.