By Nikhil Kamath
Union Budget 2020: With India’s real GDP growth at 5%, and slow rebounding in both consumption and investment, India’s 2020 Budget requires significant reform to put the economy back on a growth-oriented track. Indeed, the issues plaguing the Indian economy are both structural and cyclical; what we need in Budget 2020 are reforms which address both. On the structural side, the Indian economy faces low productivity growth across manufacturing, agriculture and industrial sectors, as well as an NPA issue which has stymied lending and investment. On the cyclical side, the past 3 years’ growth has been in largely buoyed by 1) an NBFC-led credit boom, which has ground to a halt since the collapse of ILFS in September 2018, and 2) off-balance-sheet fiscal stimulus, which is becoming increasingly untenable as the government faces a growing fiscal deficit estimated at 3.8% of GDP.
The government in Budget 2020 therefore must address the core issues of productivity growth and an all-encompassing overhaul of the credit sector, while improving the ease of doing business in India to encourage domestic and foreign investment in the economy. Government spending in skills development, infrastructure and access to health and education services are key to boosting rural and urban productivity. Governance reforms in NPA-stressed public-sector banks and NBFCs, via the recapitalization of troubled banks and the speedy execution of IBC processes for NPAs, are key measures to rejuvenating lending to the corporate sector and freeing up stressed bank balance sheets.
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Indeed, effective incentives for good lenders to continue lending to good companies (which have not picked up despite the 135-basis-point interest rate cut from the RBI in the past year) will be incredibly important to restart investment and corporate growth. Such growth would trickle down to the labor markets, and thus have an indirect yet meaningful impact on consumption. Given India’s deficit situation, with direct tax collection growth also at a 10-year low, cutting income tax rates may grab headlines but not deliver the true structural changes required to spur sustainable consumption across the population.
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In terms of the financial and capital markets, we are looking to the government to rationalize unnecessarily burdensome fees for investors participating in capital markets. India’s capital markets penetration is still abysmally low, with only 8% of the population with direct or indirect exposure to capital markets (versus 60%+ in developed markets). In order to encourage newly banked consumer to financialize their assets, the government must implement lower barriers, less complexity and better incentives.
For instance, we are anticipating the Budget to lower or remove the long-term capital gains tax for holdings of greater than 24 months, and to hopefully reduce the discrepancies in long-term capital gains taxes for listed versus unlisted securities. We are also looking at the Budget to relieve investors from incremental taxes by reducing the dividend distribution tax, and reducing or restructuring STT through tax rebates. For sophisticated investors who are already participating in the markets through equities or the f &o segment, we also strongly believe the government should undertake a rationalization on derivatives trading taxes, which may be as high as 42% in certain investment vehicles.
Derivatives improves liquidity and price discovery in our public markets, and ultimately such activity benefits the new capital markets investor as Well. Lastly, we hope the government removes arcane fees and barriers for investors in Alternative Investment Funds (AIFs). Indeed, AIFs were created as a category to encourage greater on-shoring of global institutional investors with exposure to India, and to increase engagement from the on-shore high net worth individuals to invest in India assets.
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To achieve such an aim, AIFs must exhibit similar ease and tax liability as FPI routes. Tax parity on long term capital gains from listed and unlisted shares, creating pass-through taxation mechanisms for all AIF categories, and lowering GST rates on services provided to foreign investors in AIFs are all incremental reforms required to incentivize asset managers to move on-shore. We hope the Budget 2020 can address these concerns from those of us working to push adoption of capital markets in India.
All in all, the Budget 2020 presents a definitive moment for our current government to formulate a strategic plan to address the current economic slowdown in India and demonstrate the political will for significant reform. We eagerly await the Finance Minister’s Budget presentation and anticipate substantial announcements to be made.
Nikhil Kamath is Co-founder of discount broking firm Zerodha