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Budget may boost stock markets, say analysts

BUDGET 2001

India's upcoming federal budget could boost the stock market by allowing pension funds to buy equities or by raising the foreign ownership limit, according to analysts and fund managers.

It might also reduce the 20 per cent tax on dividends and initiate action to stamp out "dividend stripping".

Finance Minister Yashwant Sinha will unveil the budget on February 28.

"It is possible that pension funds may be allowed to invest up to five per cent of their funds in equities," said Nilesh Shah, portfolio manager at Kotak Securities. He also said the foreign ownership limit could be raised to 49 per cent.

Foreign investors are currently allowed to buy up to 40 per cent of the shares of Indian companies, while pension funds are barred from investing in stocks.

Either change could fuel a rally by channelling more money into the share markets, as the past eight years have shown.

The Bombay Stock Exchange's benchmark index has risen 64 per cent since 1993 when foreign funds were first allowed to invest in Indian stocks. Foreign funds have since invested nearly $13 billion in Indian securities, becoming a major force in Indian stock markets.

Another fund manager said it was unlikely the foreign ceiling would be raised anytime soon, but added it was high time domestic pension funds were allowed to invest in equities.

"The stock market needs long-term investments which can be provided by pension funds," said Gul Tekchandani, chief investment officer at Sun FC Asset Management which manages Rs 15 billion ($322 million).

But Tekchandani said it would make little difference to the overall market whether the foreign ownership limit were raised or not.

"In most companies the foreign shareholding is far short of the 40 per cent limit," he said.

Bobby Surendranath, a fund manager at Zurich India AMC Ltd, suggested the ownership limit may be raised -- but very, very selectively.

"Since privatisation is high up on this government's agenda, the limit may be raised for VSNL to push through its divestment," Surendranath said.

On February 1 the central government announced it planned to sell a 25 per cent stake in state-run Videsh Sanchar Nigam Ltd (VSNL) to a strategic partner. But since foreigners already own 30 per cent of the Indian monopoly provider of international phone service, the stake cannot be sold to a foreign partner without exceeding the current limit.

Dividend stripping

Analysts said the finance minister may also move to plug a loophole in the current tax code by proposing changes to curtail what's known in geek speak as "dividend stripping".

The practice refers to investors who exploit the tax-free status of dividends paid by mutual funds by timing their investments to generate capital losses.

This is done by buying a fund at a cum dividend price and selling it at an ex-dividend price, thus incurring a capital loss. That loss can be set off against other capital gains to reduce taxes, while also benefiting an investor through the dividend pocketed.

"As per our estimates, the loss to the exchequer in the year to this March will be upwards of Rs 20 billion," said Surendranath.

To snuff out the practice, analysts said the government may require mutual funds to announce a book closure period for paying dividends, which would effectively lock in investors for a longer period.

The increased market exposure "would be a deterrent for anybody wanting to use this loophole," said a broker.

Investors are also waiting to see if the government lowers or abolishes the 20 per cent levy on corporate dividends.

"If the capital markets are to be revived, then dividend tax has to be abolished," said Nimesh Kampani, chairman of JM Trustee company.

Some fund managers expect the tax rate to be reduced but the tax to be broadened to include more equity investment funds.

"We are expecting that the tax may be halved and that those who are currently not paying this tax may start doing so," said Vimal Jain, fund manager at Edelweiss Capital.

Currently, funds more than 50 per cent invested in stocks and paying dividends are exempt from paying the distribution tax.

Budget 2001

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