Shift of household savings to equities has just started
For long, we have lamented that the traditional Indian penchant for saving hasn’t translated into financial investments. Recognising the role of such investments in driving economic growth, the debate has centered around measures to encourage the financialisation of savings in India. Exempting long- term capital gains ( LTCG) on equity investments is one such measure, and a good one.
Though this measure was instituted over a decade ago, in 2005, we are only now seeing some evidence of a shift in the way Indian households think of financial investments. Their savings in shares and debentures have begun to rise. Mutual funds ( MFs) are becoming the favoured vehicle for investing in equities. This is evident in the quadrupling of MF folios in the past three years. We are seeing unprecedented flows through MF systematic investment plans ( SIPs), and equity assets of domestic MFs are at an all- time high. The Indian stock markets are no longer dictated solely by foreign buying or selling.
Yet, the journey has just begun and there is still a long way to go. Though households are increasingly becoming interested in equities, the share of financial assets in overall household investments is still abysmally low. There is a need to continue encouraging financialisation of savings. Stoking households’ interest in equity markets will have a collateral positive impact on other financial assets, such as bonds and participating insurance plans. Reinstating LTCG in equities at this juncture could jeopardise a journey well- begun and something we can ill afford.
A key reason for the recent spurt in Indian households’ financial investments is demonetisation: The share of ‘ shares and debentures’ in gross financial savings tripled to over 10 per cent in 2016- 17. Indian households invested more in ‘ shares and debentures’, spurred by buoyant stock markets and expectations of superior post- tax returns. Doing away with the LTCG tax benefit that equity investments enjoy will adversely impact investor sentiment and quickly reverse the desirable trend accelerated by the demonetisation exercise. India will have lost a rare opportunity.
This is not to say that the arguments favouring a reinstatement of LTCG tax on equity investments hold no water. Instances of its misuse, for instance, are real. However, in my view, this calls for a fine- tuning of the tax provisions to prevent such misuse rather than doing away with the benefit entirely. Yes, its reinstatement could shore up revenue collection for the government but at what cost? Consider the damage that yet another disruption following demonetisation and GST implementation could do. At this juncture, I believe the costs will far outweigh the benefits.
Where we stand today, a debate on whether the LTCG tax exemption on equities should be done away with is premature. Let us wait for another five years.