Unveiled in the Budget, the Rajiv Gandhi Equity Savings Scheme (RGESS) was seen as the million-dollar idea to revive the stock market and rejuvenate the barely-alive equity cult in India.
But the final scheme, notified this week, is so structured that it seems a tall order. The scheme is complicated and has so many ifs and buts to it, that uninitiated investors may end up confused and market intermediaries may think twice before implementing it.
Only new investors, please
The restrictions start with the eligibility criteria.
The scheme’s main attraction is that investors deploying up to Rs 50,000 in equities will earn an upfront tax break of 50 per cent of the amount. But if that sounds like money for jam, there are many conditions attached. To avail of the scheme, you should have an annual taxable income of below Rs 10 lakh. You must also be a ‘new’ investor, who is yet to open a demat account; this will be verified using the PAN.
An investor who has a demat account, but for some strange reason has never transacted on it, will also count as a ‘new’ investor.
But the main glitch here is that you can only avail of this tax benefit of Rs 25,000 once in your lifetime. You cease to be a ‘new’ investor once you open an account and invest the sum of Rs 50,000.
This is quite unlike the existing tax breaks for other investments. Under section 80C, investments of up to Rs 1 lakh in select avenues are open to all salaried investors and earn you tax breaks every year. In what way is RGESS superior to the existing equity-linked saving schemes from mutual funds?
If you clear the eligibility rules, you will hit upon restrictions on where you can invest.
Why PSUs?
To benefit from RGESS, you just cannot go and buy any old listed share that you think is attractive.
The Government has decided that the equity cult cannot be built that way.
Instead, you can earn tax breaks only if you invest in a certain set of stocks that the Government prefers.
The ‘eligible’ list includes stocks that are part of the BSE 100 and CNX 100 indices and stocks of public sector unit (PSUs) that are Maharatnas, Navratanas or Miniratnas. Only secondary market investments and follow-on offers are allowed in the above companies. But, initial public offers from PSUs with annual sales of Rs 4000 crore or more will be eligible for RGESS too.
As a nod to diversification, mutual funds are allowed; but with the caveat that they must invest only in the above securities and must be traded on the stock exchanges.
Given that the vast majority of Indian funds are open-end, this will rule out almost all existing funds from the purview of this scheme.
PSUs are risky too
The investment restrictions are hard to explain. Given that the RGESS is meant for first-time investors in equities, restricting it only to the top 100 stocks in the market makes sense. This would keep risks under check.
But why should there be a special dispensation for PSUs? The notion that all PSU shares, no matter what their credentials, are somehow less risky than private sector shares, is flawed on many counts.
One, if volatility is a measure, PSU stocks in the last five years have proved much more vulnerable to market swings than other stocks.
To illustrate, in the recent market meltdown (October 2010 to December 2011), the BSE PSU index lost 42 per cent against the Sensex decline of 27 per cent. In the 2008 crash, the PSU index shed 66 per cent from its high, also more than the market.
Two, the businesses in which most state-owned companies operate are inherently risky. Oil and gas, metals and mining stocks make up over half of the BSE PSU index, and cyclical sectors such as banks and capital goods another 30 per cent. These sectors are particularly susceptible to swings in profits based on commodity price or economic cycles. In fact, many fund managers avoid commodity stocks because they fear them to be among the most risky classes of equity investment.
Then there is the scheme’s special provision for IPOs from public sector companies. To reduce risk, it is desirable for new investors to steer clear of all IPOs.
Why IPOs from PSUs of a certain size alone must be deemed good investments is unclear. In this context, the return record of past offers from public sector companies isn’t inspiring. Overall, with so many conditions designed to accommodate PSU stocks, the RGESS looks less like an altruistic effort to revive the equity market and, suspiciously, like an attempt to restart the stalled PSU divestment programme.
Lock-in
The rules for operating the account are full of complexities too. The RGESS account is required to be held for three years. But investors may sell their shares after one year, to ‘promote the equity culture’ and help them realise any profits.
But there is a catch. Even if investors do sell the shares, they must refill the RGESS account again with eligible securities. In effect, they must make sure that the value of securities in their account, for at least 270 days each year, does not fall below the initial sum for which they claimed tax benefits. (If the value falls due to the stocks tanking, that is mercifully allowed.) Investors violating the above norms are warned that their original tax benefits will be ‘withdrawn’.
These rules suggest that new investors will have to maintain a separate account for the RGESS, which they cannot use for other purposes in the first three years. It makes the RGESS account a high maintenance proposition for the market intermediaries who implement it. They will have to keep track of each investor’s account balance, his stock market transactions and portfolio value on a real-time basis.
But with the investment capped at Rs 50,000 and the scheme barred to both affluent and seasoned investors, the question is why brokers will rush to open these accounts in the first place. Overall, the scheme makes one wonder why promoting equity investments through tax sops must be so complicated.
Simply allowing an annual tax exemption to any investor who puts Rs 25,000 in equities of his choice, seems to be a much better way to promote the equity cult. Locking in that sum for five years would ensure that the sums stay in the market for the long term.