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What FM Needs To Do To Revive Stock Market?


Posted on 16-Aug-2019 Comments  0

Market Boost

What the Finance Minister needs to do to revive stock markets

Over the weekend there has been a lot of optimism and enthusiasm built round the meeting between the PM and the finance minister. With ANZ Bank now reducing India’s full year GDP growth target to just 6.2%, the problem is almost real. Here is what is needed.

Withdraw the FPI tax

The higher surcharge that the budget imposed on the super rich was really uncalled for. Higher income groups in India are already heavily taxed and it will only encourage structures to avoid the tax. More so, since this also impacts the FPIs structured as trusts. India is one of the few countries that taxes capital gains made by FPIs and that is only adding to the cost of transacting in the Indian markets. It is time to get rid of the HNI tax to give a better comfort zone for FPIs to operate in India.

Buyback tax is out of place

Buyback tax was again uncalled for. Taxing all buybacks at 20% irrespective of your cost of acquisition is likely to discourage companies and investors. The whole idea of a buyback is for a company to return capital to share holders when they don’t have better applications. Taxing that is not a great idea; especially when the weak market conditions could see a lot of companies buying back shares to give out the right signal to shareholders. The buyback tax could just distort this strategy.

LTCG tax has to go too

With the steep tax on long term capital gains, the government has effectively discouraged two things. Firstly, it has discouraged investors from booking profits to keep the money churning. Secondly, it has also added a slice of uncertainty to the long term financial plans of a whole lot of middle class investors. These investors were largely counting on the tax-free status of equity funds and now they will have to rework their plans all over again. But the big challenge is that LTCG tax hardly adds revenues and that was the reason it was scrapped in the past. The equity markets have got used to the STT and have now accepted that as part of their investment process. Scrapping LTCG tax will be a big boost.

Simplifying GST process

GST was a great idea but its efficiencies are yet to be realized due to flaws in the way it is structured. To begin with, the registration process is too cumbersome. That is still keeping a lot of small businesses away. The answer is to offer a flat rate of GST up to a certain threshold and just link it to bank funding and all state incentives. Secondly, with too many slabs, the basic purpose of one nation, one tax is defeated. With some minor tweaks, the GST can be converted into an engine of growth. The FM may not be able to do all these, but a start would be a welcome boost!

Inverted Yields

How to interpret the inverted yield curve in the US bond markets

Over the last few days, there has been a lot of debate in the public domain about the US yield curve taking on an inverted shape. This is not a normal occurrence and is being interpreted in the market as a signal of an impending slowdown in the global economy. Is it a cause for concern and what does an inverted yield curve really mean?

About yield curve economics

The yield curve measures the relation between term to maturity and the yield. The normal argument, and rightly so, is that longer the tenure, greater is the risk. Hence long maturity bonds tend to trade at higher yields than shorter maturity bonds. An inverted yield curve does not mean that the shape of the yield curve is inverted. What it means is that the yield on the 10-year bond or the yield on the 5-year bond has fallen below the yields on the 2-year bond. In the last few days, we did see the 10-year US bond yields dipping to below 1.55% and in the process going below the 2-year bond yields. This is not the first time that this has been noticed but we have got to see this at least 4-5 times in the last one year. When long term yields go below short term yields, it is an indication about caution among bond investors to take a long term view. This is seen as indicative of an impending economic slowdown. In the past, such inversions have led to a full-fledged economic slowdown in at least 80% of the cases. That is the worry!

How to read the yield signals

An inversion in the yield curve, by itself, does not imply an economic slowdown. It is only when the inversion is backed by macro data that markets tend to get worried. Currently, there is a trade war on between the US and China and that has putting visible pressure on global growth. IMF has already sliced off 40 bps from growth estimates. The bigger worry is the limitations of monetary policy. In the last 10 years since the 2008 Lehman crisis, central banks across the world have gone on a spree cutting rates and infusing liquidity. There is not much scope left for these central banks to give a further boost to growth via monetary incentives. That is one of the key reasons why the inverted yield curve has resulted in fears of an economic slowdown across the world.

Anomalous economics

What the inverted yield curve may be reflecting at this point of time are two anomalous events. For the first time in history, there are bonds worth $17 trillion earning negative yields. This time around, negative yield has become a central bank strategy. That is because central banks find it the best defence against being drawn into a currency war. When yields are negative, flows will be limited and currencies cannot strengthen. So, any currency war will be ineffective to begin with. We are surely in for some interesting times!

DVR Shares

What the new norms for DVR shares mean for corporate India

DVR shares have been around in India for over 10 years now with companies like Tata Motors, Jain Irrigation, NRE Coke and Future Group having issued such shares. Differential Voting Rights (DVR) shares offer a means to raise capital without diluting control. That is something that has come to the fore after the Mindtree case where founding promoters with just 10% stake in the company had to cede control to L&T despite their best efforts. DVR shares could have saved the day for them in such circumstances. On 16th August, the government issued new norms for DVR shares, which can help this instrument become more meaningful.

Majority voting control

One of the reasons most promoters did not relish the idea of DVR shares in the past was that the total proportion of DVR shares could not exceed 26%. That means promoters would be vulnerable to external takeover attacks. Now that limit has been raised from 26% to 74%. That means; companies will be allowed to issue up to 74% of the voting rights to the existing promoters even if the actual share of capital they own is just 10%. This will be a big boost for start up businesses and small entrepreneurs to raise capital for their business expansion without worrying about dilution of their stake. We saw forced dilution in Flipkart and loss of control in case of Mindtree. Both situations could have been avoided with DVRs.

No track record needed

One of the unsustainable conditions of the current DVR regulations was that the company needed to have a 3 year track record of profitability to be eligible for the issue of DVRs. That would have kept most start ups out of the eligible list because typically start-ups sink loads of capital into the company before they can even think of becoming profitable. Now that requirement is scrapped as per the latest announcement made on 16th August. Now, companies do not need a track record of 3 years of profits to be able to issue of DVR shares, which will again come as a boon. One more change is relevant. Currently, higher voting shares can be issued as ESOPs to promoters only within 5 years in case of start-ups. Now that has been relaxed to 10 years, which is more realistic looking at the gestation in start-ups.

Creating the DVR market

Of course, the biggest challenge will be to have an interesting story for the investors to buy into. Normal stocks without voting rights will not be exciting to investors unless other sweeteners are thrown in. A semi-convertible structure would work better where there is a fixed payout for some time before it is converted into equity. That should interest a lot of institutions. Once the regulation is done and dusted, the next challenge is to get the market excited. That is, of course, the next step!

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