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FSM in Media - NaMo's maiden Budget disappoints the MF industry
July 14, 2014

Although a few positives like uniform KYC and tax treatment for pension funds and MF-linked retirement plan have been mentioned, a more pro-MF policies could have found a place in the Budget.

Author : Dr. Renu Pothen

 Fund Managers on Short-Term Funds


This article was published on on July 11, 2014.

IThe maiden budget of the Narendra Modi-led Government was keenly awaited not only by the domestic and international market participants but also by all segments of people right from students to senior citizens. And as usual, Team Modi has succeeded in pleasing the markets and the aam junta.

The Finance Minister started his speech on these lines, "The people of India have decisively voted for a change. The verdict represents the exasperation of the people with the status-quo. India unhesitatingly desires to grow. Those living below the poverty line are anxious to free themselves from the curse of poverty. Those who have got an opportunity to emerge from the difficult challenges have become aspirational. They now want to be a part of the neo middle class. Their next generation has the hunger to use the opportunity that society provides for them. Slow decision making has resulted in a loss of opportunity. Two years of sub five per cent growth in the Indian economy has resulted in a challenging situation. We look forward to lower levels of inflation as compared to the days of double digit rates of food inflation in the last two years. The country is in no mood to suffer unemployment, inadequate basic amenities, lack of infrastructure and apathetic governance".

The first paragraph of the Budget Speech is a clear indication that the government has understood the aspirations of the people who gave a majority mandate to a national party after 30 years. The government's target of getting the economy back to a growth rate of 7-8% or above in the next 3-4 years along with the urgent need to maintain fiscal prudence shows that this government means business. Since the ascent of the BJP government at the centre, some sectors like banks, infrastructure and PSUs were on a roll on account of huge expectations that this government will be pro-growth and these are the sectors to watch out for. Today's budget has not disappointed these sectors and with a pro-FDI policy and emphasis on economic reforms taking into consideration people from all segments of the economy, the markets actually cheered the budget. However, from a mutual fund perspective, instead of making the life of investors simple and encouraging investments into this sector, the budget has done just the reverse. I am listing down my points of contention with the Finance Minister.

• Investment Limit under Section 80C of the Income Tax Act increased from INR 1 Lakh to INR 1.5 Lakh

This measure to promote domestic investments into long term savings is definitely a step in the right direction. However, if the government really wanted to promote long term investments, they should have included more equity categories under this section. This is because a majority of the instruments under this section are biased towards the fixed income space, which on an average yields returns in the range of 8% to 9%. However, if the investor has to make money which will beat inflation over a long time period, then more equity categories could have been included.

Currently, if the investor has to go in for equity funds then he has only ELSS to consider. It would have been more appropriate if additional categories like large caps, multi caps and balanced funds would have been included. This is because investors entering into the ELSS category are doing so with their eyes closed and are parking their surplus without even checking how the portfolio is positioned. For instance, if an Investor is conservative, then taking an exposure into an ELSS, whose maximum corpus is put into mid and small caps, will only subject the investor to volatility.

• To remove tax arbitrage, rate of tax on long term capital gains increased from 10 percent to 20 percent on transfer of units of mutual funds, other than equity oriented funds.

I like the way the Finance Minister has said in his Budget Speech that the tax arbitrage provided to mutual funds has not really benefited retail investors. Well, that's there for everyone to see, with the banking sector already garnering more than 50% of the financial savings of the household sector into its fold and only 2.5% of the same surplus coming into mutual funds. My question is why is the government encouraging the diversion of financial savings into the banking sector and refusing to take a look at the mutual funds industry? A tax arbitrage alone will not help the industry in getting the desired surplus. For that the government will have to come out with conducive policies for the industry.

• I also propose to increase the period of holding in respect of such units from 12 months to 36 months for this purpose.

This measure is not acceptable to the investor community as debt funds are supposed to meet short term goals of investors. They are not to be held like equity funds for a period of 3 years and have to be actively managed. Hence, if an investor has a time horizon of 1 year and if his investment goal is to pay for the tuition fees of his child, then what are the options left for him? In the current scenario, we would have recommended a short term fund with a time horizon of 1 year and the option would be growth. With the new rule in place, this same investor would have to go in for a short term fund and take a dividend option to meet his goal. As the goal has to be met in 1 year, he will not be able to take advantage of the long term capital gains of parking his surplus into a debt fund. Hence, rather than encouraging savings into the mutual fund industry, the Government has made mutual funds an unfavorable option for investors.

• Income and dividend distribution tax to be levied on gross amount instead of amount paid net of taxes.

This measure requires more clarity which will be available in the next few days. However, overall we feel that this ultimately means that DDT would increase the tax burden of investors.

To conclude, like all the other market participants, we in the mutual fund industry had hoped that we would be a part of Team NaMo's pro-reform agenda. Although a few positives like uniform KYC and uniform tax treatment for pension funds and mutual fund linked retirement plan have been mentioned, we are of the strong view that more pro-mutual fund policies could have found a place in the budget.

Dr. Renu Pothen
Research Head-Investment Advisory Division
The Investment Advisory Division is a part of iFAST Financial India Pvt Ltd

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