The reason why the market fell over 2% in reaction to Friday’s budget announcement

Sensex

Ever since the budget announcement on Friday the biggest casualty has been the stock market. So nervous were our indices on Monday’s trade that they wiped out ₹ 3.4 Trillion in market cap or investor wealth in a single day.

The benchmark BSE index tanked 793 points to end at 38,721 levels, equalling a loss of 2.01%. The broader 50 share Nifty index was down 253 points to close at 11,558 points, which equalled a loss of 2.14%.

This translates into the worst single day loss in nine months since October 11th 2018. A sea of red could be seen all across the screen with advance decline ratios not even worth mentioning.

For a budget that was expected to spur investment, growth and demand, the stock market, which is often referred to as the barometer of the economy, seemed to read the signals exactly opposite.

But what’s got the market so spooked that it’s running for cover?

If one scratches below the surface it’s not that hard to point out just what aspects of the budget have managed to scare the daylights out of investors.

A combination of global and local factors have played a part in this. The most important global factor is better than expected jobs data in the US now puts the brakes on hopes of a rate cut by the Federal Reserve, which hit market sentiments.

But more importantly, the recent budget proposals such as increase in minimum public shareholding to 35%, proposal to tax buy back on shares, an increased tax on foreign investment, increased surcharge on high income earners above ₹ 2 crore, lack of stimulus provided by the budget, sliding economic growth and also other factors such as a discovery of a fresh fraud at Punjab National Bank are weighing in on investor sentiment and proving to be dampener on the market.

However, in our opinion, the two most important factors that are to blame are the increase in the minimum public shareholding of listed companies from 25% to 35% and an additional surcharge levied on foreign portfolio investors (FPIs).

Coming to the first point of contention, which is the raising of minimum public shareholding from 25% to 35%.

The government has made it mandatory for listed companies to have a minimum public shareholding of at least 35% with a view to avoid concentration of shareholding in the hands of promoters and give them autonomous control over their entities. Besides, it also limits the scope of market manipulation, promotes equity culture and encourages better corporate governance.

The move however, is expected to impact 1,400 listed companies including TCS, Wipro, HDFC Life Insurance, Avenue Supermarts, Bandhan Bank etc. The problem the market views with this is that now promoters will have to sell 10% of their shares in the open market and with valuations being so high, there would not be enough demand in the market to absorb these shares which would lead to excess supply and affect price stability. And, with this rule coming in, companies with promoter shareholding beyond 65% are likely to underperform in the next two years.

To give some perspective, TCS alone would be required to sell shares worth ₹ 60,000 crore to reduce its promoter stake from 72.05% to the proposed 65%.

The second bone of contention is the increased surcharge on foreign portfolio investors (FPIs) which comprise of mutual funds, pension funds, sovereign wealth funds etc. and Alternate Investment Funds (AIFs). Combined, these contribute to inward foreign investment in a big way. The additional surcharge which was made applicable to all non corporates earning income above ₹ 2 crores would also be applicable to FPIs and AIFs because most FPIs and AIFs are structured in the form of a trust and would find themselves paying taxes as high as 42.74% if their income exceeds ₹ 5 crore. With this budget proposal, we would find many foreign investors pulling out of India as they are not used to paying taxes at such high rates and would prefer to migrate to other emerging markets.

In today’s trade as well markets began nervously with the Nifty index cracking more than 100 points, it however managed to recover and end the day flat.


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