Political upheaval = investment prospect

In case of correction, long-term investors should increase their SIP allocations

Politics is likely to be the dominant concern for investors until May 2019. There are five assembly elections in the next four weeks and campaign fever will build up until the General Elections of April-May 2019. This will be a period of increasing volatility.

The macro-fundamentals look a little shaky. Geopolitical tensions are high. The World Bank has cut its estimates for 2019 global growth. However, more than fundamentals, market returns in the next few months will be extremely volatile and very likely negative due to prospects of political change.

Suppose for example, investor consensus is that the current government is doing a good job. Then, there will be nervousness at the thought of a new formation coming to power. If consensus is that the current government is doing a bad job, there is nervousness at the thought it might retain power! Opinion polls and assembly results might be inaccurate when it comes to predicting Lok Sabha results but these will influence market movements. Obviously a war that affects crude prices, or a major terror attack, an assassination, etc., could change sentiment for the worse.

There are three major possibilities so far as the formation of the next Lok Sabha is concerned. One is that the current government will continue to be in charge, with policy continuity. The second possibility — and this seems the consensus opinion now — is that the BJP is unlikely to retain a majority, although it will very likely, be the single largest party. In that case, India is looking at a coalition which would work differently from the current presidential- style of governance. The third possibility is an entirely different coalition without the BJP. The fourth possibility — that any party other than the BJP can win a majority — is considered unlikely.

My guess is that the first three possibilities will be rehashed repeatedly in public discourse over the next seven months. The market will swing each time, but of course, it will swing in different directions depending on the news flow. The net effect is likely to be negative, with price corrections across the board. By the time of the Lok Sabha elections, the market is likely to be trading lower.

The second historical pattern is that the market generally recovers once there is a government in place, whatever that government might be. We’ve seen this, even with the ragtag coalitions of the late 1990s and we saw it in 2005-6 after the National Democratic Alliance was voted out. Fundamentals reassert their importance once political formations are known.

Let’s look at likely growth rates and valuations. Index valuations are still pretty high, with the Nifty trading at a price-to-earnings (PE) 25-26, while the Nifty Midcaps-250 is at PE 32-33 and the Smallcaps is at PE 6364. Where the Nifty is concerned, there’s easily room for 25 per cent correction, to bring valuations back into the mean-median range of PE 19-20. Treasury yields are roughly in the 78 per cent range. If we’re comparing earnings growth to debt yields, we should be looking for valuations in the PE-14-15 range. The Nifty rarely falls till those valuation levels but PE 17-18 does happen often enough.

An optimist would assume earnings for the Nifty basket at nominal Gross Domestic Product ( GDP) growth (inflation + real GDP growth) plus some growth premium. Assume inflation stays at 4-5 per cent, GDP grows at 7.5 per cent (real) for 2018-19. The earnings per share (EPS) for the Nifty should grow at 13 per cent or better. The past two years have seen single-digit EPS growth but Q1 and Q2 suggested some acceleration is on the cards. Anyway at an assumed EPS growth rate of 13 per cent and a PE of 20, the Nifty would be fair-value at roughly 9,400 by April 2019.

As an investor, anywhere in that 9,400-9,500 zone looks like a decent long-term investment. As any experienced investor knows, corrections can go a lot deeper than fair-value. While a long-term passive investor should continue averaging at current levels ignoring the political noise, he or she should increase equity commitments if the index falls below 9,500.

Technically speaking, corrections till 7,700-8,000 Nifty are quite possible. Rather than panic, long-term investors should be increasing their systematic investment plan allocations if that does happen. Look at political upheaval as an investment opportunity. The Indian art industry is nascent compared to developed markets such as the US, the UK and China, even as high net-worth individuals (HNIs) are increasingly looking at including works of art in their investment portfolios. The huge interest shown by India’s wealthy population has prompted London-based auction house Sotheby’s to host its inaugural sale in Mumbai this December. This is the first time the auction house will be hosting a sale in the country after its first attempt three decades ago.

A few HNIs are also using artwork for portfolio diversification. Some wealthy individuals buy their art overseas by remitting money abroad under the liberalised remittance scheme, and keep it with the galleries in the same country. This helps them maintain an asset in another currency that has the potential of capital appreciation.

As more individuals look at collecting and investing in visual art, the income-tax department has increased its scrutiny as well. “It’s easier to evade taxes using artwork. It’s easier to determine the valuations of other assets such as property, gold, and financial instruments, as there are standard procedures laid down. Valuation of art is subjective. The department is, therefore, more alert,” says Gopal Bohra, Partner, NA Shah Associates.

Individuals collecting art need to ensure that they have their paperwork in place to show how the artwork was procured and that the valuation was correct when it was bought. Those bequeathing their collection need to take measures to insulate their beneficiaries from tax troubles in the future.

Register for GST: Since the introduction of the Goods and Services Tax, artists, galleries and buyers have complained that the new system will hamper the sale of art. In some cases, it makes buying art more expensive than before. Some provisions require compliances that artists, buyers and galleries feel are unwarranted and unreasonable.

Under the new taxation structure, artwork, including, paintings, drawings and pastels, original engravings, original sculptures and antiquities more than 100 years old, fall under the 12 per cent tax bracket, rendering them more expensive than they were prior to GST implementation. “Earlier, selling of artwork attracted excise duty in most cases. Many states had exempted sale of artwork from excise,” says Utkarsh Sanghvi, tax partner, EY India.

The movement of art outside the artist or collector’s state also has the notion of sale. If someone is sending artwork from Mumbai to Delhi for an exhibition, the person

has to pay tax on the declared value at the point of origin. Sanghvi suggests that the buyer also registers for GST. If an individual sells artwork worth ~2 million in a financial year, he is now liable to pay GST. Registering for GST will also help the buyer to claim the credit if he sells the painting in the future.

Buy from registered dealers: In India, a significant number of sales are conducted privately. “Discretion has conventionally been one of the art industry’s keystones,” says a report by KPMG and Ficci titled ‘Visual Arts Industry in India: Painting the Future’. It states that while there are a number of noted art galleries and auction houses that account for a majority of formal art sales in India, there exist numerous art dealers and galleries across the country whose sales are not accounted for. Sales data from the such dealers lacks transparency. “This is largely because a majority of such art dealers and galleries across India are small establishments and sole traders without employees, sales conducted by whom go unreported and untaxed,” says the report. Trying to save tax when buying from these sources can prove costly in the future.

Artwork received as a gift from overseas: If a person receives artwork as a gift, the taxation is the same as that for other gifts. If it is from a close relative, there will be no tax. If a distant relative gifts artwork, the receiver needs to get the valuation done from an authorised valuer and pay the applicable tax. Things can get a little complicated if a close relative abroad gifts artwork to someone in India.

The receiver will need to first pay the customs and Integrated Goods and Services Tax on the artwork to import it into India. “In such cases, the receiver is better off keeping extra paperwork that establishes that the gift is genuinely from a close relative and the valuation,” says Indruj Rai, associate partner, Khaitan & Co. Ask the sender to give a copy of the invoice that bears the relative’s name. The relative can also give a declaration about the gift. In such cases, the burden of proving that the gift is genuinely from a close relative would lie on the taxpayer.

Make inheritance of art worryfree: Bequeathing artwork bought decades back and for which the owner doesn’t have invoices or bank statements can create problems for the beneficiary. “When bequeathing works of art, describe them in detail in the Will. Include details such as title, year in which the artwork was made, artist’s name, and describe the piece in a few sentences,” Rai.

Those earning ~5 million or more need to declare specified assets, including art, when filing income tax returns. Mentioning all your assets including artworks will keep you on the right side of the law.