The Budget 2019 proposal on the income tax rebate is most beneficial for the lower and middle income group – and is estimated to put 3 crore tax payers out of the tax bracket.
As expected, the Interim Budget for FY2019-20 was aimed at pleasing farmers as well as the middle class. The proposal is to offer full income tax rebate for taxable income up to Rs 5 Lakh. Individuals with taxable income between Rs 2.5 lakh and Rs 5 lakh can save up to Rs 12,500 in taxes, giving them a higher disposable income. In addition, standard deduction for salaried employees has been increased from Rs 40,000 to Rs 50,000.
The new proposal is most beneficial for the lower and middle income group – and is estimated to put 3 crore tax payers out of the tax bracket. The increased disposable income would increase consumption and encourage investments as well, but before we get into how an individual should look to invest, let us briefly illustrate the tax savings on account of the tax proposals.
Those with incomes above Rs 5 lakh can take advantage of this rebate, by taking advantage of deductions available, which can reduce their taxable income. Firstly the standard deduction means salaried employees with income up to Rs 5.5 lakh will not have to pay tax.
Secondly, an individual can take advantage of deductions available under various sections to reduce their taxable income. For instance, specified investments under Section 80C offer deductions up to Rs 1.5 lakh. There are a few other avenues available, like deduction for medical insurance of Rs 50,000, deduction of Rs 200,000 for interest paid on home loans, and contributions up to Rs 50,000 in the National Pension System or NPS.
Salaried employees with annual income of up to Rs 10 lakh can thus reduce net tax liability to zero. While this is being offered as a tax rebate, not as change in tax slab, the reduction is still significant. Salaried with taxable income in between Rs 5 lakh and Rs 10 lakh can save Rs 2,080, and those with taxable income above Rs 10 lakh can save Rs 3,120.
In addition to this, the limit for TDS threshold has been hiked for interest earned on bank / post office deposits to Rs 40,000. TDS for threshold for deduction of tax on rent has been increased to Rs 2,40,000 from Rs 1,80,000. Put together, households will have additional disposable income.
While the choice of savings vs consumption is dependent on an individual’s circumstances as well as preferences, we recommend that individuals should save and invest the increase in tax savings as much as they can. According to an HSBC global survey on retirement savings “Future of Retirement: Bridging the Gap” only about 33% of Indians are saving regularly for retirement. With increase in life expectancy, the need for retirement savings is even higher.
We believe that the tax proposals will increase financial savings, further boosting the trend towards financial savings which has already been visible in the last few years. Indians are increasingly investing in financial assets as compared to physical assets such as gold and real estate. As per the RBI Data, physical savings declined by Rs 180 billion, whereas financial savings rose by Rs 2,140 bn, both from FY2013-14 to FY2016-17.
Those with income between Rs 5 lakh and Rs 10 lakh will strive to increase deductions via instruments that qualify under the various deductions. Tax saving instruments like ELSS, life insurance, voluntary PF & PPF, small savings schemes should witness increasing flows. In order to maximize wealth creation opportunities, investment in ELSS, which are equity oriented mutual funds with tax savings, would be a better option among the instruments that qualify for deductions under section 80 C. Subscribers to the National Pension Scheme or NPS may also increase. This is positive on account of two reasons; firstly this increases the pool for retirement savings, thus increasing old age security. Secondly, inflows to capital markets, especially equities, will increase. It is important to note that NPS has recently allowed subscribers to opt for a higher percent of allocation towards equities.
However, increase in inflow will not be limited to tax deductible instruments alone. Other instruments may witness increase in inflows. This will be across asset classes- fixed income, equities.
Fixed deposits and government-run small savings schemes are traditional ways of fixed income exposure. However, these days there are other options one should consider, like debt oriented mutual funds. They offer some advantages over traditional fixed income- they offer better liquidity and are more tax efficient. Returns of debt oriented mutual funds are higher, though the buyer is exposed to additional risk.
Equities are an asset class to which households have low exposure to. Only 6% of household savings are invested in equity markets, which is extremely low when compared to other countries like the US, Hong Kong and Singapore where it is somewhere ranging in between 37-48%. Over a long term, equities outperform other asset classes and offer the best avenue to beat inflation and create wealth. Investors can get access to equities via investing in stocks directly or via equity-oriented mutual funds. Investing via an SIP in an equity-oriented fund is a way to build wealth in a disciplined manner.
Domestic Institutional Investors or DII’s are becoming an increasingly important part of our capital market. Mutual funds have experienced exponential growth. Currently Rs 7.9 lakh crore are under management in equity schemes, up from Rs 1.8 lakh crore 5 years back. In January 2000, the AUM of equity funds stood at just 26,000 crore. SIP inflows in December 2018 were at Rs 8,000 crore. With this they have emerged as a counter weight to Foreign Institutional Investors.
We believe that equities can perform well in 2019, while the first half is likely to be subdued, largely on account of the upcoming elections. If elections result in the formation of a stable, reform-oriented government, the markets will move up. Our research indicates that markets have risen by 12.5% (on an average) in the six months following the elections after the last 4 elections.
For those looking to invest directly in stocks, budget measures are positive for consumption. We believe that FMCG and discretionary consumption stocks will get a boost. In our investment outlook for 2019, we are positive on stocks geared to discretionary consumption. In addition we like banks and the capital goods sector.
In conclusion, we believe that the budget measures will result in an increase in disposable income. We would recommend that individuals should use this to invest to create long-term wealth. Exposure to equities offer the best option for wealth creation and this can be achieved via investment in ELSS, other equity-oriented mutual funds as well as direct investment in equities.
(By Rajiv Ranjan Singh, CEO-Stock Broking, Karvy)