The Bombay Stock Exchange indices said it all.
Faced with a weakening economy, the finance minister has lowered the income-tax burden, leaving more money in the hands of taxpayers. Add to that the money from the Sixth Pay Commission, the waiver of farm dues, the expenditure on social sectors , the directive to banks to lower lending rates and to lend more to farmers and there’s little doubt that consumption demand will get a boost.
On a day when the Sensex fell 1.38%, BSE’s fast moving consumer goods (FMCG) index moved up 0.9%, the auto index 1.2% and the Bankex 0.4%. Apart from the healthcare index, which was flat, other sectoral indices were in the red.
The problem is that the finance minister has budgeted for lower capital expenditure compared with the revised estimates for the current fiscal year. The net impact: the finance minister has budgeted for growth of 5.9% in total expenditure (capital plus revenue), while the expenditure estimates for FY08 are 21.6% higher than the actuals for FY07. That’s not so good and the market seems unimpressed by the extent of the boost provided.
Of course, part of the reason lies in the blow to sentiment dealt by the new taxes imposed on market participants. Short-term capital gains tax has been increased from 10% to 15%. Besides, the securities transaction tax (STT) paid by traders will no longer be offset against their total tax liability, but would be treated as a deduction from taxable income, which will lead to an increase in tax incidence. The impact will be the largest for proprietary traders who arbitrage on thin spreads. The higher the transactions and the lower the profit spread, the higher the impact. For instance, a trade with a 0.1% profit spread will lead a 40% increase in transaction costs if one were to include income tax as part of transaction costs. Increase the profit spread to 1% and the rise in transaction costs would be lower at 4%.
The finance minister has also imposed tax on services provided by stock exchanges, which would lead to a further increase in transaction costs for brokers and their clients. Since these moves will particularly impact short-term traders and arbitrageurs, there could be an impact on liquidity. Option traders, however, got some relief as the STT on their trades will be linked to the premium paid rather than the entire value of the contract, unless the options get exercised, in which case STT would apply on the entire contract amount.
The relief for holding companies on the dividend distribution tax front will lead to higher payouts from these companies, resulting in an increase in dividend yield. State Bank of India, for instance, can increase dividend payout by 12% because of the proposed tax saving.
Companies would also benefit from the 2% reduction in excide duty to 14%. In a number of cases, prices would not be decreased because of the small change in excise duty and hence there could be a 200 basis points positive impact on margins on such products.
Auto companies stand to gain among the most, considering that the reduction in excise duty is as high as4percentage points for a number of products. Most of these stocks had gained a day prior to the Budget based on this expectation, and have now gained about 5% on an average. Some companies have stated that the benefit will be passed on to customers. But it’s more likely that while official prices are reduced, discounts offered earlier would be withdrawn. This would help auto companies tide over the pressure of inflation cost.
Pharmaceutical companies gained from the halving in excise duty to 8%, but, for companies such as Sun Pharmaceuticals Ltd, which have shifted a large part of their production to tax havens, this would only mean a reduction in their cost competency. For others, it levels the field to some extent. Stocks of companies focused on research and development lost in value as some market expectations on the weighted deduction of research and development expenses were not met.
Cement companies got a raw deal as the excise duty has been effectively raised for bulk cement. Alchemy Share and Stock Brokers Pvt .Ltd estimates that bulk cement accounts for 25-30% of total cement sales, but the terms of the contracts with bulk customers are such that the additional levy will be passed on. Considering that demand exceeds supply currently, the increase in prices would barely impact sales. Alchemy notes that companies have the option to reduce sales of bulk cement by just printing the retail sales price on each cement bag.
The markets were hoping that the tax benefit on software technology parks would be extended, and the 2.7% drop in BSE’s information technology (IT) index reflects the disappointment on this front. As estimated by most analysts, the effective tax rates for IT companies will increase sharply in financial year 2009-10.
And finally, after plunging initially, bank stocks went up after bankers said they would be compensated by the government for writing off the bad loans, most probably through an issue of bonds spread over three years, although the details of the scheme are still awaited. The point is that banks would have had to provide for these loans anyway and they would benefit if they get even some amount from the government. Also, some of the bad loans have already been provided for, so the bonds have to be issued only for the balance. The real problem lies in the future: agricultural borrowers now have a powerful incentive to default on their loans.
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