Budget Impact on Capital Markets

Debt Capital Markets

Union Budget 2002-03 failed to live up to the expectations of bond market participants. While the market had been expecting a 100-150 basis points cut in the small savings rate, the Finance Minister soft-pedalled on the issue and cut interest rates on small savings by only 50 basis points. With the RBI not expected to announce any change in the Bank Rate and the Cash Reserve Ratio till Apr 02, bond prices, which had been rallying prior to the Budget, crashed afterwards. Moreover the government's high borrowing programme is expected to act as a dampener on the currently prevailing soft interest rate regime.

Equity Capital Markets

The finance minister's decision to tax dividends at the hands of investors rather than continue with the current dividend distribution tax on companies, impose 5% tax surcharge and reduce benefits under Section 88 of the Income Tax Act; will affect the investible surplus of retail investors, and consequently their equity market investments. However, with FII portfolio investments not subject to sectoral limits for foreign direct investment except in specified sectors, FII investments in the equity market are expected to rise.

Viewed from another perspective, with rates on small savings being cut and interest rates being benign, the retail investor has not been left with many options to maintain his current return on investment. This factor could in fact see more money flowing into the high-risk high-return equity market.

Income/Gilt funds

The Net Asset Value of most income and gilt funds is expected to decline as prices of bonds have crashed. Moreover dividend schemes of debt funds could also come under redemption pressure on account of changes in tax treatment of dividend. There is likely to be a flow of funds to growth plans of income/gilt schemes as investors would prefer to wait for one year and pay capital gains tax, rather than pay income-tax on dividends.

I-T sector funds

With the 100% deduction of export profits allowed to certain units under sections 10A and 10B of the Income-tax Act being reduced to a 90% deduction, net profit of software companies set up in software technology parks and which are currently availing 100% deduction of export profits under the aforesaid section, will be hit. However, the Budget announcement enabling Indian companies to invest up to US $ 100 mn on an annual basis through the automatic route, as against the existing limit of US $ 50 mn is expected to aid companies with expansion plans in overseas markets. This will enable easier acquisition of overseas companies by top-tier Information Technology companies such as Infosys. Funds, which are bullish on top-tier I-T stocks, could benefit.

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