Will the removal of surcharge on FPI capital gains help stock market?

Lokeshwarri S K | Updated on August 24, 2019

Other reasons including trade war and global turbulence are behind FPI selling

BL Research Bureau

The Finance Minister’s efforts to assuage Foreign Portfolio Investors is likely to help lift the pall of gloom over Indian equity market. But it is unlikely that the stimulus announced so far will materially impact stock price moves.

The most significant part of the FM’s booster measures was the removal of additional surcharge applicable on capital gains on equity and equity mutual funds recorded by high income earners. Since this surcharge impacted some FPIs, it had been widely perceived that the decline of close to 10 per cent in the Nifty 50 since the Union Budget had largely been due to this tax tweak.

FPIs had pulled out close to ₹12,400 crore out of Indian equity market in July and had followed it up with outflow of ₹12,105 crore in August. While it is true that FPI pull-out led to the market fall, the reason for FPI selling was not necessarily the additional surcharge.

Why are FPIs selling

If we consider the data on FPI fund flows this year, they had net purchased ₹80,314 crore between February and May this year. It is obvious that the foreign investors with a short-term horizon who make event-driven bets were banking on Modi returning to power for a second term and were therefore pumping in money. Once the election outcome was known, they waited until the Union Budget to see if any big bang reforms were on the anvil.

But with most of the big announcements already made in the interim budget in February 2019 and against the backdrop of the fiscal constraints, the Union Budget, 2019, was a dampener. This seems to have made the short-term FPIs who had brought in money prior to the elections, hit the sell button.

Two, there has been excessive turbulence in global markets since late July when the Federal Reserve cut Fed Funds rate. With the US President ratcheting up the trade war due to the less-than-demanded rate cut by Powell and with China retaliating with currency devaluation and further tariffs, global risk aversion has spiked. In such situations, foreign portfolio money tends to move out of riskier assets such as emerging market equities.

It is seen that while FPIs pulled out $1.9 billion out of South Korean stocks, $2.5 billion from Taiwanese stocks, $1.6 billion from Thailand stocks and $2.6 billion from Brazilian stocks in the last one month. This is in line with the $1.5 billion outflow from Indian equity.

Three, it was observed that FPIs had been net buyers in Indian bond market, net purchasing $2.4 billion of Indian bonds in this quarter. Since the surcharge on capital gains is equally applicable on debt investments as well, this contrary behavior shows that the additional tax is not really a deterrent.

Four, the poor performance on Indian equity market vis-à-vis other equity markets, the steep valuation, when compared to other emerging markets and the poor earnings growth in recent quarters could have had a greater impact on FPI decision to invest in Indian equity rather than the additional surcharge.

How will market react

Those expecting a strong opening on Monday morning are likely to be disappointed with trade war resuming on Friday. China has decided to impose tariffs on $75 billion of US imports and Trump has retaliated by increasing the tariff on $250 billion of imports from 25 per cent to 30 per cent. All Wall Street indices sank more than 2 per cent on the news and the nervousness will spill over to trades in Indian markets on Monday morning.

Stability is unlikely to be restored to Indian stocks as long as the trade war continues, impacting global trade and growth. Foreign investment money typically tends to flow in to safer havens such as dollar and gold at times such as these when risk aversion is high.

That said, the measures announced for auto and banking sectors, are likely to help the market sentiment somewhat. If the Centre fulfills its promises in easing the funding constraints for MSMEs, housing and consumer oriented industries and the infrastructure space, it will be positive for the market from a long-term perspective.

Other tweaks

Other tweaks announced by the FM for capital markets to develop credit default swaps and deepening the Indian bond market and allowing Aadhaar based KYC will help Improve Indian equity and bond markets. But these will be effective only in the long term.

Similarly, measure to allow rupee derivatives to be traded on the GIFT IFSC will help move the offshore trades in the rupee to onshore and thus give RBI greater control on rupee movement. But these are also likely to show an impact over the long-term only.

Published on August 24, 2019

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