A 0% short-term capital gains tax to pull in money into stocks

Written by Shobhana Subramanian | Updated: Feb 27 2013, 07:29am hrs
India was the best performing market last year with the Sensex putting on some 24% in dollar terms as foreign institutions shopped for some $25 billion worth of stocks. But retail investors back home missed the party; data from mutual funds shows that most investors seem to have have cashed out in the rising marketbetween January and December last year equity schemes saw inflows only in the month of May. Its not as though theyre punting on their own because retail participation in the markets has stagnated for a long time now delivery volumes throughout 2012 stayed low at around the R850-crore mark with November seeing a particularly sharp dip to R225 crore.

How disenchanted small investors are with equities and bonds is clear from the fact that investments by households, in shares and debentures, actually contracted by some R6,500 crore in 2011-12 , after increasing by R44,800 crore in 2009-10. While the bulk of household savings, in a country like India, will always flow into into bank deposits, it is unfortunate that investments into bonds and equities can be negative. Some of this has to do with regulation; the ban on entry loads, in August 2009, virtually killed the mutual fund industry leaving agents with little incentive to push these products.

So while the rest of the world rode the rally in the Indian market the Sensex hit a life-time high in November 2010 investors at home sat it out giving up a fantastic return of 50% or more for a paltry 2% entry load.

Subsequent efforts by the regulator to try and encourage agents have been at best marginal and met with no success. Also, while insurers did see big collections from ULIPs in the initial years, that came to an end once the usurious commissions were cut. To be sure there was a fair amount of mis-selling, especially in ULIPs and to some extent in mutual funds, but at the end of the day households must be encouraged to put money in equities. While the MF and ULIP pieces need to be fixed, the government could give the markets a leg up by doing away with the capital gains tax on listed securities, currently at 15%.

The government collects some R3,000 crore from this levy which, while not an insignificant amount, isnt very large either. A zero% short-term capital gains tax could pull investors back into the market, boosting the sentiment like little else can; given how one year can be a long time in such a dynamic world, investors would be comfortable knowing they can quit when they want to without being taxed for it. More participation in the markets will only make them more liquid. In short, a strong market will allow corporates to raise equity while not pressuring the fisc too much; the biggest beneficiary of this move will be the government since its hoping to raise a bunch of money from disinvestments.

If the markets rallyas they should now that corporate earnings seem to be bottoming out the government can more than make up the R3,000 crore from higher premiums on the shares that it plans to sell. Whats more, over-indebted corporates can de-leverage, taking the pressure off both their own balance sheets as also those of banks. As for the economy, theres nothing like the wealth effect to get consumers spending.