The unexpected hike in capital gains tax in the Union Budget 2024, released on July 23, has left Indian investors in stitches. The BSE Sensex fell nearly 1,000 points while the Nifty 50 ended marginally positive after dropping over 300 points in intraday trade.
The Nifty 50 fell 30.20 points or 0.12% to close at 24,479.05, while the BSE Sensex declined 0.091% to close at 80,429.04. Here are some of the reasons behind the decline in the Indian equity market:
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Key reasons for the decline in the Indian stock market
The budget’s focus on fiscal consolidation and deficit reduction may have raised concerns about a potential slowdown in economic growth and availability of liquidity in the markets.
Tax Changes: The government recently announced increases in long-term and short-term capital gains taxes as a revenue-raising measure. Long-term capital gains tax has increased from 10% to 12.5%, while short-term capital gains tax on certain assets has increased from 15% to 20%. These changes have led investors to take profits, putting selling pressure on the market.
Prolonged Rise and Profit Taking: The extended bull market saw stock prices reach their peak, setting the stage for a correction. Investors began selling their holdings at higher prices to take profits, leading to a broad-based sell-off across sectors. As prices reached new highs, market participants reassessed valuations, leading to a more cautious approach and subsequent sell-offs.
Stocks are overpriced: Many stocks are trading at high prices in the Indian market, but it is becoming increasingly difficult to justify the same based on their fundamental performance. High Price to Earnings (P/E) ratios and other valuation metrics indicate that many stocks are trading at high prices. Investors are wary of these unsustainable valuations and have started selling stocks to lock in profits, leading to an overall market decline.
Options Market Impact: The options market also played a key role in the recent market movements. The concentration of call options at various strike prices forced market makers to sell the underlying stocks to hedge their positions. This move put downward pressure on the market as the options neared their expiration dates, exacerbating the decline.
Stocks that fell sharply
Several major stocks experienced significant losses, leading to a decline in the overall market.
Hindalco: -3.50% Larsen & Toubro: -3.16% ONGC: -2.62% Shriram Finance: -1.97% Power Grid Corporation: -1.68% Bajaj Finance: -1.54% SBI Life Insurance: -1.37% Coal India: -1.11% SBI: -1.05%
These declines reflect broader negative sentiment and market weakness.
What does the future hold for investors?
The recent budget announcements have garnered mixed reactions from experts across sectors, who are of the opinion that the budget will primarily benefit investors across the board and create a level playing field across asset classes.
According to T Manish, research analyst at Samco Securities, the new tax regime will result in a significant savings of around INR 17,500 for individuals due to revised tax rates and hike in standard deduction from INR 50,000 to INR 75,000. The measure is expected to benefit fast moving consumer goods (FMCG) companies such as HUL, ITC, Dabur and Nestle, with suppliers such as Polyplex and Euphrex also seeing secondary benefits.
“Furthermore, rising savings are likely to lead to increased inflows into asset management companies through systematic investment plans (SIPs) and into stock broking firms through brokerages,” Manish said.
Vaibhav Porwal, co-founder of asset management firm Dezerv, believes the capital gains tax changes will ultimately foster a more stable and mature investment environment. “The wider differential between STCG and LTCG tax rates will encourage long-term holding, leading to sustainable wealth creation. It will also standardise taxation across asset classes, simplify investment decisions and encourage patient capital despite short-term market concerns due to adjustments in securities transaction tax (STT), especially on derivatives,” says Porwal.
Vaibhav Gupta, partner at Dhruva Advisors, pointed out that the reduction in long-term capital gains tax for residents on unlisted shares and real estate and the increase in tax rate for non-residents on unlisted shares to 12.5 per cent from 10 per cent will impact foreign direct investment (FDI) returns.
“Abolition of cost indexation of all assets will significantly impact real estate returns. However, Indian promoters selling unlisted companies will benefit from tax reduction of 12.5% from 20% as there will be parity between sales of listed and unlisted shares. Changing the treatment of capital gains on bonds and debentures to short-term gains taxed at applicable rates, clarifying the taxability of transfer of shares in offers for sale and indexation up to FY18 are notable adjustments,” Gupta said.
To weather the storm of volatility, experts believe investors need to focus on these key factors:
Diversification: Maintain a diversified portfolio to reduce risk. Valuation awareness: Pay attention to stock valuations and avoid overpriced stocks. Market trends: Understand how market instruments such as options can affect stock prices. Long-term perspective: Maintain a long-term investment horizon to weather short-term fluctuations.
Although the current market downturn is challenging, it could present an opportunity for smart investors to buy quality stocks at more reasonable prices.
Conclusion
Today’s stock market decline can be attributed to a confluence of factors that have led to a destabilization of investor sentiment. The main factors include:
Tax rate revisions: The Union Budget’s announcement of tax rate revisions, especially hikes in Short Term Capital Gains Tax (STCG) and Long Term Capital Gains Tax (LTCG), has led to a bearish market reaction. The changes have created uncertainty among investors, prompting selling. Securities Transaction Tax (STT) changes: The adjustments in Securities Transaction Tax, especially on derivatives, have impacted the profitability of frequent traders. This has contributed to the overall negative sentiment in the market. Impact on Foreign Direct Investment (FDI): The increase in long term capital gains tax on unlisted shares for non-residents from 10% to 12.5% is expected to impact FDI returns, raising concerns of lower foreign investment inflows. Abolition of cost indexation: The abolition of cost indexation for all assets is expected to have a significant impact on real estate returns, with a ripple effect across related sectors. Market adaptation to new policies: The market is adapting to the wide range of changes introduced in the budget, including changes in capital gains tax and treatment of share transfers. These adjustments have created a period of volatility as investors reassess their portfolios. Short-term perspective: The market is currently reacting to these policy changes with a short-term perspective. While some experts advocate for a focus on long-term gains, the immediate reaction has been negative.
In summary, a combination of revised tax rates, changes in STT, increased taxes on non-resident investments and de-indexation of costs have contributed to the stock market decline today. Investors are in the process of re-evaluating and adjusting to their new financial situation.
