January was a good month for Indian markets with both Sensex and Nifty rising 5.6% and 4.7% respectively. During the month, the indices scaled new life highs on the back of the expectations of good corporate results in Q3 and strong industrial growth data.

Monthly Returns

But eventually, the rise was road-blocked by a combination of LTCG announcement in the budget, hardening yields and weak global equity markets.

Markets remained volatile during the early part of February and in fact, fell for 5 straight sessions after the budget and were down by more than 5% after a week.

Budget 2018

As expected (and highlighted in the previous newsletter), the government did indeed go for a delicate balance of prudent economics and pre-election populist measures.

Clearly, the focus of the Union Budget was on agriculture and the rural sector.

To address the growing farm distress, the minimum support prices (or MSP) were fixed as a multiple of production costs.Government is also working to ensure that a mechanism is in place to ensure delivery of MSP to farmers in case the government is not the end-buyer or market rates fall below benchmarks. This is in addition to government promising spending on rural infrastructure to boost growth and supporting employment.

All these measures can create employment opportunities and improve rural incomes. But how much of that is actualized will depend on the actual extent of government spending that reaches grassroot levels.

An ambitious universal health protection scheme has also been announced to cover almost half the country’s population (being referred as Modicare by many). As is with all such mega announcements, operational implementation without bureaucratic leakages of funds will be the key here.

We feel that though the government would have planned its revenues accordingly and in light of these increased expenditures, a higher than expected crude oil price environment could put pressure on the government to cut taxes on petroleum products, which could affect its revenues. Hence, this will be key monitorable and will consequently, result in government further pushing for stabilization and increasing the base of GST to augment its coffers.

You can read more about our view on the Budget in this detailed note.

Return of Long-Term Capital Gains Tax in Equities

The advent of this was always expected but the timing was slightly surprising.

But ending almost a decade long tax holiday on long-term capital gains on equity, the government announced a 10% tax on these gains, over and above the gains of Rs 1 lakh.

Post this announcement, the markets are still trying to find their feet and a reasonable correction and volatility are embracing the markets. Though it would be wrong to attribute the entire fall in markets since early February to LTCG tax, the fact is that it did act as a trigger.

One of the big reasons for this move is that India (as of 2017) has a booming stock market. So the government felt that a small part of this prosperity should go towards propping up government’s revenue and thus, help fund reforms and infrastructure spendings.Also, LTCG tax will help improve the share of direct taxes in total tax revenue and to some extent, moderate the gap between the rich and the poor.

But credit should be given to the government where its due.

The decision to implement the tax has been done in one of the best possible ways. Like introducing the concept of grandfathering (of gains before 31-Jan-2018) to reduce the impact and slowly easing this change into investors’ psyche. Of course it could have been tweaked further (like providing indexation benefits, etc.) but that’s a discussion for another day.

And to be fair, given the way LTCG is treated in most parts of the world and considering the income profile of the people making those gains, a moderate tax was justified to correct an anomaly whereby the incentives were unfairly skewed towards high net-worth entities and individuals.

We as long-term investors ourselves are obviously impacted. But this is a new reality for all market participants and it will get factored in as we move forward.

R&R View on Economy & Markets

After a strong and non-volatile 2017, the year 2018 is off to an interesting start. And as we had highlighted in our article ‘Why 2018 will be eventful?’ (link), the events in February and more specifically the Union Budget has been eventful one no doubt.

But let’s try to look at the bigger picture.

There’s been criticism that the budget is populist. But to be fair, it blends both economy and politics. LTCG tax is no doubt an unpopular decision but a fair one. And this clearly points to one thing – that the government does not shy away from taking difficult and unpopular decisions.

In words of the finance minister, “Whether it’s demonetization, insolvency and bankruptcy code or goods and services tax (GST), these are difficult decisions…”. And rightly so. Structural reforms can create temporary upheavals, but there are larger gains available down the road. And that is what we as long term investors having a bullish view on the Indian growth story should focus on.

On that note, we end this newsletter and as always, appreciate you for taking time to read this message. Do share your views/comments by email/comment section below.

Regards
Team Equentis