(Bloomberg) -- India made significant changes to taxes on gains from equity investments and stock derivatives for the first time in decades, seeking to curb the surge in speculative trading in the nation’s $5 trillion market.
The government raised the levy on stocks held for less than 12 months to 20%, the first hike since 2008, and to 12.5% from 10% for those held for more than a year, according to the budget presented in parliament Tuesday. The securities transaction tax on equity options was hiked to 0.1%, and to 0.02% on futures, effective from October.
The surge in India’s equity derivatives volumes to the highest in the world has spurred anxiety that this frenzy may hinder efforts to channel household savings for productive uses. In January, the notional turnover reached $6 trillion, surpassing the size of India’s economy.
“As an equity investor, one can’t be happy about the increase in both the long-term and short-term capital gains,” said Arun Chulani, co-founder at First Water Capital. “Despite the current halo effect of India’s golden decade, we are still competing for foreign capital against other emerging markets.”
Government officials have repeatedly raised the alarm in recent months over the significant retail participation in derivatives trading, with the finance ministry’s Economic Survey on Monday warning that this influx is likely driven by “humans’ gambling instinct.” Earlier this year, the market regulator stepped in to temper the IPO market, and recently asked stock brokers to put in mechanisms to prevent and detect fraud.
Still, the stock market took the tax blow and warnings in its stride. The benchmark NSE Nifty 50 Index recovered nearly all of its losses after dropping as much as 1.8% after Finance Minister Nirmala Sitharaman announced the changes in her 90-minute long presentation.
Indian equities are set for a ninth straight year of gains, boosted by its tag of the world’s fastest-growing major economy, a gush of local money and strong corporate profit growth. With the government retaining its focus on infrastructure spending as well as its commitment to fiscal conservatism in Tuesday’s budget, stock bulls still had plenty to cheer.
The tax changes are “not expected to significantly impact market sentiment,” said Vikas Khemani, founder and chief investment officer at Carnelian Asset Management & Advisors. “We remain confident in investing in India.”
To be sure, the momentum in equity derivatives trading had begun to ease in the weeks leading up to the budget amid a series of warnings from authorities aimed at curbing retail participation.
The notional volume shrank more than 40% from its peak in February to $3.3 trillion on Monday, data compiled by Bloomberg showed.
Traders are awaiting the recommendation of a panel set up by the Securities and Exchange Board of India last month to suggest ways to improve investor protection in the derivatives segment.
To cushion the impact on small investors, the exemption limit for capital gains eligible for tax exemption has been raised to 125,000 rupees from 100,000 rupees earlier.
The tax hike “will undoubtedly impact the profitability of frequent traders,” said Vaibhav Porwal, co-founder at wealth management firm Dezerv. The widening gap between short- and long-term capital gains tax rates is “a clear incentive for long-term holdings,” he said.
--With assistance from Catherine Ngai.
(Adds details on regulatory action in fifth paragraph)
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