“The life of a finance minister is not easy and I must be cruel only to be kind” were the words of the finance minister Mr. Pranab Mukherjee in his union budget speech. Has the finance minister been really kind or was it his cruelty that the markets did not like the overall budget.
With the conclusion of the Union budget 2012 and after reading the fine prints, the investors realised what actually the finance minister left for them in their kitty. Though the finance minister tried to maintain a balance between reforms and fiscal consolidation in his budget speech, it finally turned out to be more generous for the rich who will become richer and left very little for the low income earners. So, if you fall in the high income category with earnings of over Rs 10 lakhs per anum for FY 2012-13, then the savings on your income tax will be Rs 22,660, while if you earn anywhere between Rs 2 Lakh to Rs 8 Lakh, then with the new tax slabs, your savings from taxes will not be more than Rs 2,060. So it is not that your high savings will result in high earnings, but instead your high earnings will result in high savings on your personal taxes.
Also to enthuse savings habit among individuals, the finance minister wants us to invest in bank deposits, and has offered an exemption on the interest income of upto Rs 10,000 in the next fiscal year
The finance minister also did try to boost new retail participation in equity markets by providing an additional tax incentive under Rajiv Gandhi equity savings scheme (having 3 year lock-in), allowing tax deduction of 50% for investments upto Rs 50,000 directly in equities. And this incentive remains for new retail investors with annual income of less than Rs 10 Lakhs. Hence, if this scheme is able to attract even 1 crore new investors to the equity markets, then the retail participation in equity markets can increase by Rs 50,000 crore; which can be a huge long term money in the equity markets and having capacity to boost the equity markets in FY 2012-13. However, we will see the benefits of this flowing only in the next financial year, when more clarity comes in on Rajiv Gandhi equity savings scheme.
Though the much awaited reduction in STT by 20% i.e. from 0.125% to 0.10% on cash delivery transactions brought some cheers to the equity markets, this will encourage more savings in Indian equities and give further boost to the stock market activities.
However the economic indicators were discouraging for both equity and debt markets. The markets didn’t like the GDP growth targets being pegged at 6.9% for FY 2011-12 and 7.6% for FY 2012-13, while even the upward revision in the fiscal deficit targets to 5.9% for FY 2011-12 and 5.1% for FY 2012-13 didn’t go well with both equity as well as debt markets. The finance ministers’ strategy to achieve the 5.1% fiscal deficit target by increasing the indirect taxes like Service Tax and Excise Duty from 10% to 12% will hurt the industry, as goods and services are expected to get dearer which will in a way push the inflation upwards. The increase in inflation is not good for the economy as oil prices are not expected to cool down any sooner and the further boost in prices of goods and services due to additional tax burden will keep the inflation high. This will stop RBI from cutting policy rates anytime soon, which will also keep the borrowing rates higher for a long time and impact the net profit margins of the companies. Investors who invested in debt markets in anticipation of benefiting from rate cuts may have to wait longer.
On the other hand, the budgeted spending for infrastructure at Rs 50 lakh crore during the 12th Five Year Plan with half of this expected to be from the private sector; along with the proposal to double the limit for tax free bonds to Rs 60,000 crore for financing infrastructure projects will help boost the infrastructure sector and enthuse confidence in the long term growth story of India.
Strategy for Equity Market Investors: While the union budget 2012 depicts discomfort in the short term in terms of the impact on the profit margin of the companies, the increase in tax net by the finance minister and his focus on reforms and fiscal consolidation may turn out to be good for the economy only in the long run. Equity investors have something to cheer about, which will boost the confidence of long term investors. The emphasis towards improving savings habit among the retail investors by encouraging participation in capital markets seems to be good for the long term. Equity investors should not hold back on their investment plans, if they have some good investment decision to make. But invest with a long term time horizon in mind. Retail investors can also benefit from investing in well diversified and well managed equity mutual funds with a superior track record.
The government’s disappointment on controlling its expenditure is a matter of concern as it has not been able to cut down on expenses and the total expenditure for the fiscal year 2013 has been budgeted at Rs 14,90,925 crore, which is too high. Among these the planned expenditure will be Rs 5,21,025 crore and non-plan expenditure is budgeted at a whooping Rs 9,69,900 crore. With a fiscal deficit target of 5.1% of the GDP, the government plans to net borrow Rs 4.79 lakh crore to finance this deficit.
The finance minister has played safe by keeping a higher borrowing target of Rs 4.79 lakh crore for FY 2012-13, which will from the very beginning put an additional burden on the RBI to raise funds for the government. As the government will make its additional borrowings from the bond markets, the RBI will have to maintain the supply of bonds and efficiently manage the Open Market Operations. This has kept the debt market participants wondering on the extent of additional load that they will face to finance the governments additional borrowings.
As the finance minister allowed Qualified Financial Investors to access the Indian corporate bond markets, this step can be very encouraging and intended to deepen the participation of foreign investors in the Indian corporate bond markets. This move will help increase the funding options for corporates who can raise long term money via bonds from foreign investors.
Strategy for Debt Market Investors: With all this, the yields on the longer duration instruments are hardening as RBI may have to offer higher rates to meet the borrowing targets for the next financial year. Also RBI will become cautious and go slow on rate cut measures that was much awaited to boost the economic performance. The debt market has already given thumbs down to the overall budget and the yield on the 10 year G-sec 8.79% 2012, has moved up by 10 bps in just 3 days and is slowly heading towards the 9% mark. The 9% yield levels look possible if the liquidity continues to remain tight and RBI does not initiates its rate cut measures in its policy meeting scheduled in April 2012.
Over the year, the markets will closely watch the government’s strategy towards meeting its disinvestment target of Rs 30,000 crore which is around 3 times of what it has been able to achieve in the current year. The short fall in this will again be financed by the debt markets as the government has no other source of revenue apart from tax and asset sales. Investors who invested in debt markets in anticipation of benefiting from rate cuts may have to wait longer.
It will be prudent for you to know your investment time horizon before investing in fixed income instruments and debt mutual funds. As currently the short term rates are high due to tight liquidity conditions, you can benefit from being invested in mutual funds having exposure to shorter maturity instruments. While investment in funds that are able to manage their portfolio duration will be suitable if you have a medium term time horizon in mind. For investing in long term fixed income instruments like bonds and long term debt mutual funds>, you should have a time horizon of over 3 years in mind. It is advisable to stay away from G-sec funds if you need your money within next 1 to 2 years, as you may see high volatility in the performance of G-secs if yields keep on inching upwards. And do not forget to lock a small portion of your investments at these higher rates, as these high rates may not prevail for a long time. A fixed rate of return from a highly rated instrument offering 9% to10% p.a. over a period of 3 to 5 years is a good choice. But you need to also work out the post-tax net returns that you will be left with on maturity.
As the finance minister in his budget presentation speech announced a further hike in customs duty on standard gold bars and gold coins with over 99.5% purity to 4% from 2% and on non-standard gold to 10% from 5%, it will make the precious metals more expensive for the investors as well as end consumers. This additional duty will have an adverse impact on the development of gold market in India and may also keep the demand for the precious metals under check in the short term, as it may turn out to be more expensive for price sensitive investors from an investment purpose as well.
Though this step by the finance minister is towards discouraging gold consumption, but India being one of the largest consumers of gold, its attractiveness towards gold will stand strong in the long run. The duty increase may somehow help fill government’s kitty through imported gold, but will have less impact on the overall demand for gold.
Strategy for Gold Market Investors: You should keep holding around 5% to 10% allocation to gold in your investment portfolio. The value of gold for the existing investors has increased over the longer period of time and with the additional duty, it will increase further. Though your new purchase will be more expensive at higher prices, you should take benefit of any fall in gold prices and slowly keep accumulating gold for a long term investment, which will at the time of crisis also act as insurance in your investment portfolio.