Falling Markets – is budget the reason ?

On 5th July, 2019, India’s finance minister Mrs. Nirmala Sitharaman presented the first Union Budget after the much-anticipated General Elections this year. While many believed that given the mandate which government had this time, it could be one of those revolutionary path-breaking budgets which will fire up the animal instincts of economy and boost growth. However, none of it happened and the common perception is that budget is more of a socialist dole-out and carefully avoids any big structural reforms. Here, I will go on to explain five such measures, which the markets have been particularly unhappy about:

1. Borrowing through the overseas bond market

One of the main announcements by the government was the intent to borrow money (Approximately $10 billion) by issuing government securities in the overseas market. Currently, India’s external debt to GDP ratio is one of the lowest at about 5%, which it can afford to increase. But why borrow from overseas markets? The main reason is that the government is currently crowding out India’s debt market. In such a scenario, it becomes difficult for private enterprises to borrow from the market. Also, this overseas borrowing will help the government keep stable on their aggressive fiscal deficit, which brings us to the second important takeaway from the budget. However, the flip side of this can be very harmful if not managed carefully. This precisely was the reason for South-East Asian economies crashing in late 90’s. If not managed carefully, this could spiral into a vicious cycle of debt downgrade. As we write this article, the decision to borrow externally have been put on hold given the tough resistance it was facing from many sections.

2. Fiscal deficit

These are two words along with a figure that have been floating around in the business circles for quite some time now. Every government has multiple sources of income like taxation, sale of sovereign bonds and profits from public companies. On the other hand, governments also end up spending quite a lot of money on projects for public good like infrastructure or government schools and colleges etc. Fiscal deficit is the term used to denote the gap between a governments’ spending and it’s income. When the fiscal deficit number becomes too high, then you know that a country is living beyond it’s means and can lead to destabilizing an economy of any size leading to spiraling effects. In this budget, the Indian government has set a target of limiting the fiscal deficit to 3.3%, down by 0.1% from the interim budget in February. This they believe will come through higher incomes from aspects like higher GST collection and be controlling their expenditure. Expectations from this budget were not so much around containing fiscal deficit as they were around given a fiscal boost to revive flagging growth. However, none of it happened and markets seem to have disliked the idea of prioritizing fiscal prudence over growth.

3. Tax on buyback

This is one part of the budget that has got a thumbs down from the equity market. Last year, the government imposed a 20.56% Dividend Distribution Tax or DDT on equity dividends which meant that the companies had to deduct the tax at source before distributing dividends to their shareholders. As a work around, a few companies, especially big software firms, started employing a mechanism of buyback. Through a structured buyback, companies were able to offer the benefit to shareholders without the tax implication. This new tax imposition has effectively closed the doors on the same.

4. Minimum public shareholding raised from 25% to 35%

Prior to the budget, for publicly listed companies, minimum public shareholding in listed companies had to be 25%. However, in this budget the finance ministry proposed that the shareholding threshold be taken up to 35%. This proposal could end up affecting 25% of the total companies listed on the IndianExchange and about 167 companies in the BSE 500 exchange. In a market that is already wobbly and unsure in sentiment, this adds an added infusion of equity which could lead to a mismatch of supply and demand. This proposal is yet to be discussed with SEBI and could well be implemented over a period of a few years, instead of this year itself.

5. Surcharge on income tax for the rich

When it comes to individual income tax, there was only one small change announced. The surcharge for the super-rich, individuals earning Rs. 2-5 Crore and those earning more than Rs. 5 Crore annually was raised to 25% and 37% respectively. While it impacts 5000 people, this robin hood tax has been initiated with the aim of redistribution of wealth from the rich to the poor.  This also has inadvertently hit FPI (Foreign portfolio investors) who are structured in a Trust format and thus, will now end up  paying tax at the Maximum Marginal rate of 42.74%

When it comes to the economy or the Union budget, every small change matters a lot. More often than not, it’s the signaling by government which decides the future course of markets. And in this case, the signaling and posturing by government is not to the liking of Markets – which are reading this as a turn towards populism and socialism. Perhaps, the budget is heavy on process improvement and long-term pragmatism, completely ignoring short-term economic cycle and sentiment. Only time will tell if this will really lead to a dramatic improvement or more slowdown in the economy. Till then, Indian investors can only hope & pray for some global headwinds and low interest rate regime to ignite some action.