July 2019: Economic slowdown and higher taxes take a toll on markets

With the Nifty-50 down 5.7% and the Nifty Midcap 100 Index down 9.8%, July 2019 has been a difficult month for equity investors. This came as a bit of surprise for most, particularly after a very strong election mandate. The negative sentiment in the stock markets really started in Jan-2018 when the government introduced the long term capital gains tax, but the Nifty has held up rather well during this period. Since 31-Dec-2017, the Nifty is up 5.5% whereas the Nifty Midcap 100 Index is down 24.7%. Among the Nifty 500 companies, about 36% are down more than 50% from their 2 year highs and the median stock is down 41%. On the whole, it has been a tough phase for the stock market.

One of the reasons for the recent sell off has been the negative reaction to the recent budget which was announced early July. The provision of higher rates of surcharge on high earners has also included in its net, certain categories of FPIs (Foreign Portfolio Investors) who are organized as trusts. This seems to have resulted in FPIs selling about $ 2 billion of Indian equities in the month. Most countries have a benign tax treatment for foreign capital. Moreover, FPIs have consistently invested in the Indian capital markets over the years and own nearly 20% of Indian stocks. Any major disruption to this flow of capital will have an impact on the market. The tax provisions would require many FPIs to change their incorporation structure, which will take time and add unnecessary costs. The end objective of this provision is not clear.

Also, the tax on buy-backs, will have an influence on dividend payout policies of many companies. Promoters with large holdings in highly profitable companies are likely to change the payout policies. In the process, the tax collection impact may not be material, but it will result in less money in the hands of investors. Higher taxes result in an increase in the pre-tax return that an investor or entrepreneur would require for a particular project to be deemed viable. This is likely to push back the already delayed, revival of the private sector investment cycle.

Economic growth has been weak over the last 9 months – some of the issues can be traced to the ILFS crisis and its resultant impact on NBFCs in general. There is clear evidence of the economy slowing down with the recent quarterly GDP growth rate coming down to under 6% pa. Corporate growth rates have also slowed down. There seem to be bottlenecks in credit flow to businesses. The situation is quite severe in sectors like automobiles, real estate, etc. Given the high potential of the Indian economy and with the budget planning on a nearly 8% real GDP growth, we need private sector investment to get the economy back on track. A sense of urgency is required to get corporate growth rates back, as this will affect tax collections, jobs growth, etc.

While the market as a whole seems to be in a bit of a funk, we find that the high quality space, which is our focus area, has held up reasonably well over the last 18 months, and although we are finding some good opportunities in this market carnage, this is not true across the board. Many high quality companies are still trading at lofty valuations, which make them unattractive as investments. We expect that the next few months should be a good hunting ground for us to scout opportunities for investment. The Indian economy holds a lot of promise for the future, but the recent weakness is a cause for concern. We hope that the recovery shall happen sooner rather than later, and there is sufficient policy thrust on enabling broad based private sector investments in the economy.