The benchmark BSE Sensex retreated 792.82 points, or 2.01%, to 38,720.57, its biggest single-day drop since 11 October. During the day, the index fell as much as 2.3%, the most since 11 October 2018.
The broader 50-share Nifty index ended trading at 11,558.60, down 2.14%, its worst single-day fall since 11 October 2018.
Budget proposals to raise the minimum public shareholding of listed companies to 35%, a 20% tax on stock buybacks and an increase in the surcharge on high-income earners will weigh on stocks and affect returns of investors, analysts said. There are also fears the surcharge would apply to foreign portfolio investors (FPIs) and category 3 alternate investment funds (AIFs).
Stocks also fell across the world on Monday after strong US jobs data indicated the Federal Reserve might not cut policy rates in a hurry. Stocks in Japan, China, Hong Kong and Korea were down 1-2.6%.
According to Amar Ambani, president and research head of Yes Securities, markets also suffered from concerns over fund flows into the secondary market and the discovery of a new ₹3,805.15 crore fraud at Punjab National Bank (PNB).
“The hike in surcharge in the Union budget will have an adverse impact on high-end consumption, as well as reduce the investible surplus of high-income individuals, whose money was the mainstay of mutual funds, portfolio management schemes and the mid-cap segment," Ambani said. “The increased surcharge also has a bearing on FPIs coming in through the trust route and taxation of category 3 AIFs. This potentially reduces the post-tax attractiveness of India, vis-à-vis other markets, where such a high rate doesn’t exist."
Pradeep Kesavan, senior vice president (equity strategy, institutional equities) at Elara Capital, attributed the decline to a combination of global and domestic factors. “Globally, a positive payroll expansion ahead of estimations has led to a fear of anticipated Fed rate cut not coming through. This fear of consequential impact on global flows has been felt across emerging markets. Domestically, proposals in the budget to increase minimum public shareholding levels to 35% was a dampener, along with a 20% tax on share buybacks. All these added to the fact that there were no immediate measures announced in the budget, which could kick-start consumption and related economic activities. With valuations not particularly cheap any more, all these factors weighed heavily on the market and precipitated a fall," said Kesavan.
The Finance Bill for 2019 said the higher surcharge would be applicable to all non-corporate entities, something that would impact all foreign funds and AIFs established as trusts. More than 2,000 funds are feared to fall in this category.
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Under the new surcharge slabs, derivatives trading done by FPIs earning more than ₹5 crore a year could attract a tax rate of 42.7%, up from the current 35.8%. The rate will increase to 39% from 35.8% if the fund earns between ₹2 crore and ₹5 crore a year.
“The budget says the surcharge levy is on all non-corporate entities; so FPIs and AIFs established as trusts will attract the surcharge. I do not think that was the intention, I am hoping the ministry would issue some clarifications," said Riaz Thingna, director of Grant Thornton Advisory Pvt. Ltd.
At a press briefing on Monday, finance minister Nirmala Sitharaman said there was no need for a clarification on FPIs, Reuters reported. However, separately, Central Board of Direct Taxes (CBDT) chairman P.C. Mody said the government was looking into the grievance of FPIs.
Buoyant foreign fund flows are critical to maintain momentum in the markets as domestic institutional investors (DIIs) are in sell-off mode. Year to date, FIIs have bought Indian shares worth $10.97 billion, but were net sellers of shares worth $368.29 million in July so far. On Friday, they were, however, net buyers of Indian equities worth $87.22 million. In 2019 so far, DIIs have sold ₹6,897.19 crore in equities.
Bank of America Merrill Lynch said the budget was not the “catalyst" markets were hoping for. “Little is expected to happen top-down in India for the next several months. MSCI India should move in line with emerging markets. Unless growth improves, the broader market will likely remain weak given high valuations and poor earnings," its analysts said in a note on 5 July.
However, brokerage firm Nomura said the budget’s overall positive signal should supersede these concerns for now. “Given our view of lower growth, tax buoyancy is likely to disappoint and will require expenditure pruning to meet the budgeted fiscal deficit target," it added.