Weekend Reflections – Week ending 27th July 2024

Week ending 27^th July 2024

# Markets

Indian markets resumed their upward trajectory on Friday, rebounding from the heightened volatility triggered by the Union Budget 2024’s capital gains tax hike and an STT increase on derivatives. Despite less favourable global cues and foreign portfolio investors pulling out of Indian equities following the budget announcement, the indices staged a notable recovery with Nifty 50 reaching a new peak of 24861 and Sensex ending 81322 on Friday shrugging off economic survey highlights that market cap to GDP ratio has surged to 124% in FY24 from 77% in FY10.  Long awaited parity on LTCG between listed and unlisted space however, cheered private equity players at large.

Budget nos. cheered Bond markets and drove down the yields. Fiscal deficit, unchanged in absolute terms for four years, is expected to decline to 4.9% of GDP in FY25 and below 4.5% by FY26. Gross market borrowings estimated much lower at ₹ 14.01 lakh cr. and likely to be much lower in case tax revenues are higher than budgeted. 10Y yield already dropped down to 6.93% driven by lower borrowings as the numbers are defendable thus helping a stable yield in coming months.

US GDP increased at a 2.8% annualised rate in the April-June period after rising 1.4% in the previous quarter. The economy’s main growth engine—personal spending— was up 2.3%, more than projected. US Bonds rallied sharply as signs of a slowing economy and a recent stock market rout fuelled calls for quicker interest rate cuts from Fed reserve with 2-year yield falling as much as 9 bps to 4.34% and 10Y yield softened to 4.19%.

A massive selloff in technology mega cap stocks in the US has reverberated across the global financial markets, sparking fears of the artificial intelligence (AI) bubble bursting. But as the latest earnings show, the hype around AI, machine learning and other technologies is now giving way to questions around execution and the time needed to recoup the massive investments. On a weekly basis, Dow Jones registered 1% gain while Nasdaq and S&P 500 reversed its losses on Friday marginally.

# 2 RBI

2.1 RBI late on Thursday proposed revised guidelines on Liquidity Coverage Ratio [LCR] for banks, which would be applicable from April 1, 2025. LCR is a certain proportion of High-Quality Liquid Assets [HQLA] that banks need to maintain at all times. It includes cash, reserves with central banks, and federal government bonds, which can easily be converted into cash. Banks now need to set aside higher stock of liquid securities as a buffer on deposits amidst risk involving increased use of technology to transfer funds.

• Aimed at enhancing the liquidity resilience of lenders amidst an increased use of digital infrastructure
• Banks apply an additional 5% reduction in the stability of retail deposits that have internet and mobile banking access.
• Banks need to assign an additional 5% run-off factor for retail deposits enabled with internet and mobile banking facilities (IMB). Stable retail deposits enabled with IMB shall have a 10% run-off factor, and less stable deposits enabled with IMB shall have a 15% run-off factor.

Given the significant penetration of internet and mobile banking, the proposed changes are likely to increase the outflows in the next 30-day bucket for banks thereby posing higher requirements of high-quality liquid assets. This is aimed at preventing a scenario similar to Silicon Valley Bank’s collapse. Banks are likely to add government bonds in the run up to the implementation of these guidelines.

2.2 RBI on Wednesday tightened norms related to cash pay-out service at banks, making it mandatory for lenders to keep a record of recipients.

• Cash pay-out refers to arrangements for amounts being transferred out of bank accounts to beneficiaries not having a bank account.
• For cash pay-in services, remitting banks and business correspondents (BCs) will have to register the customer based on a verified cell phone number and a self-certified ‘Officially Valid Document (OVD)’ as set out in the KYC rules. The transaction message will have to include an identifier to identify the fund transfer as a cash-based remittance.

The RBI has revised its October 2011 framework related to ‘Domestic Money Transfer’. The new norms will come into effect from 1 November 2024. The revised guidelines are aimed to prevent instances of money laundering and fraud.

# 3 SEBI

3.1 SEBI through its consultation paper has proposed inclusion of summary proceedings for certain violations of securities laws by intermediaries. The summary proceeding is a legal mechanism designed for the swift resolution of cases without the need for a full trial.

 

• The new provisions are designed to expedite resolution times, potentially concluding cases within 50 days—a substantial reduction from the current timelines.
• Will be used for cases such as expulsion of members by stock exchanges or clearing corporations, termination of depository agreements, and non-payment of registration fees, among others.
• Violators will have 21 days to respond to the allegations, with SEBI aiming to issue a final order within an additional 21 days. Notably, this process will not include personal hearings.

The existing procedure involves issuing a show cause notice and providing an opportunity for personal hearings, which can extend over several months. It is believed that the new provisions would significantly streamline this process, making it faster and more efficient. This proposed change also aligns with global standards for efficient market oversight

# 4 Economy

4.1 As per HSBC Flash India Composite Output Index released on Wednesday,

• Private sector activity rose to a three-month high of 61.4 in July from 60.9 in the previous month. Backlogs of work rose further, prompting the best upturn in employment in over 18 years, according to the survey report
• The Manufacturing PMI was at a three-month high of 58.5 in July from 58.3 in June, signalling a historically strong improvement in the health of the sector.

The India Services PMI Business Activity Index was 61.1 in July as against 60.5 in June.

4.2 $42 trillion is the Wealth accumulated by the world’s richest 1% over the past decade, nearly 34 times more than the combined wealth of the poorest 50%, as per Oxfam report released last week.

# 5 PE/VC

As per IVCA/EY report released last week,

• Private equity funds and venture capital funds investments have risen 8% year-on-year to $31.5 billion in the first half of 2024,
• The amount of funds invested is 30% higher than the July-December 2023 period
• of deals increased to 654 during the six months from 441 in the preceding six months and 439 transactions in the year-ago period.

On a lighter vein!

Individuals who regularly upload videos to social media, make podcasts or write about current affairs online could be classified as digital news broadcasters, according to the new draft of the broadcasting bill. Beware before posting!!

Budget 2024 Analysis

The budget 2024, with its focus on 9 key priorities, aims to propel India’s economic potential to new heights. Nine priorities listed are Productivity and resilience in agriculture, Employment skilling, HRD & Social Justice, Manufacturing and services, Energy security, Infra, Innovation and Research development and Next gen reforms. A good budget addresses immediate socio-economic priorities while also laying out a strategic and comprehensive approach for long-term growth. The budget 2024 does just that.

The budget adopts a “focused solutions for focused problems” approach, effectively balancing social spending and capital expenditure while managing the fiscal deficit.
While there are several aspects in the budget, we wish to highlight “problems” and “solutions” through the budget announcement in 7 key areas, as considered relevant from Fund Manager’s perspective.

1.Agriculture:

The Indian agriculture sector provides livelihood support to about 42.3 per cent of the population and has a share of 18.2 per cent in the country’s GDP at current prices, registering an average annual growth rate of 4.184 per cent at constant prices over the last five years. While the country is a major agriculture producer, being the second largest producer in rice, wheat, cotton, among other crops, and the largest producer of milk, pulses and spices, the crop yields in the country are much lower than the other major producers.

Solution:

• Whenever we hear the word ‘agriculture’ in the context of the annual budget, we also hear the words ‘payouts’ and ‘subsidy. This budget was different. It rightly identified Productivity and Resilience as Priority No; 1 instead of freebies and subsidies
  Allocation has therefore been marginally increased to ₹ 5.94 trillion.
• Propose to facilitate digital public infrastructure for coverage of farmers and their lands in 3 years. Digital crop survey for kharif using dpi will be taken up in 400 districts. Agri Stack – a database of farmers in India with details like their agriculture landholding, GPS coordinates of each plot and crops grown on them – will cover 60 million farmers by the end of this financial year. This will eliminate fake claims and reduction in subsidy demands.
• New 109 high yielding and climate resilient varieties of 32 field and horticulture crops will be released for cultivation by farmers.
• New proposals aimed at Atmanirbharta for oil seeds such as mustard, groundnut, sesame, soyabean and sunflower.

2. Employment:

As per economic survey only 4.4% of India’s young workforce is formally skilled. India’s workforce is estimated to be nearly 56.5 crore in 2022-23, needs to generate nearly 78.51 lakh non-farm jobs annually. This means that most young workers have not received formal training or education specific to their jobs. While the number of employed people has gone up by 3% over the past seven years, the unemployed crowd has grown by 12%. Job creation hasn’t kept pace with the rising number of job seekers.

Solution:

The government has stepped in with three new employment-linked incentive schemes aimed at both employers and employees.

• The plan is to pay newly employed folks registered under the Employees’ Provident Fund (EPF) their first month’s salary, up to ₹15,000, if they earn up to ₹1 lakh a month.
• Plus, employers get reimbursed up to ₹3,000 per month for two years for EPF contributions for each new hire.
• There’s also a similar deal for the manufacturing sector with slightly different rules.
• intends to skill 20 lakh youth through 1,000 upgraded Industrial Training Institutes over the next five years. And there’s a government-backed loan scheme to help 25,000 students with financial assistance for these programs. This approach isn’t just about creating 50 lakhs more jobs, but also about encouraging the youth to upskill through government training programs, making them eligible for that extra first month’s pay.

Govt’s budget outlay for employment generation is staggering ₹ 2 lakh cr over 5 years through five different schemes.  What will be key to watch would be execution of these schemes.

3. MSMEs:

Currently there are 63 million MSMEs, facing a credit gap of over ₹44 trillion with credit penetration being only 11%. In the nano-micro segment, which makes up over 99% of the MSMEs, this gap is more exacerbated. As the economy grows to a USD 10 trillion economy, the increase in the debt requirement of the overall economy will in turn drive the need for credit supporting. MSMEs.

Solution:

• Credit guarantee scheme for MSMEs in the manufacturing sector – different from current Credit Guarantee Scheme which is only up to a loan limit of Rs 5 cr. The proposed scheme would be a self-financing Fund to provide loan limit up to Rs, 100 cr. Will facilitate MSMEs looking for expansion with high tech machinery and equipment.
• Credit support to MSMEs during stress period through guarantee from Govt. – currently during the Special Mention Accounts period (period before declaring NPA) no financing is provided. Now this facility will help genuine MSMEs to come out of the sudden stress.
• Reduction in turnover threshold of buyers for mandatory onboarding on the TReDS platform from INR 5 billion to INR 2.5 billion. This will help on board more and more MSMEs avail trade financing through the platform. With addition of trade insurance and onboarding of NBFCs, this will facilitate working capital for MSMEs at a cheaper rate.
• New assessment model for MSME credit. Banks would now explore partnerships with Fintechs using digital footprints, till they develop in house capability, for assessment of credit to MSMEs unlike traditional models.
• Increase in Mudra loans to ₹ 20 lakh from ₹ 10 lakh under Tarun category where borrowers have availed loan and good track record.

4.Investments:

Imposition of Angel Tax, introduced from 2012 caused enormous stress amongst early-stage startups. Angel tax is payable by a closely held company on the issuance of shares to any person on the aggregate consideration received more than the fair market value of its shares issued. Govt. in 2023 also removed the exemption provided to overseas funds from Angel Tax provisions. Valuations under the Foreign Exchange Management Act and the Income Tax Act could be different, making the tax implications even murkier for startups. More than the intent of money laundering inadequate comprehension on valuation by IT officials caused more trauma to startups. Funding plummeted to just $ 11 billion which was a whopping 70% lower than FY 22.

Solution:

Budget proposes abolition of Angel Tax completely for all types of investors from 1^st April 2025. Dismantling the entire law on entry valuation is thus considered a bold move.

Capital gains taxation so far, favoured flow to listed space with lower rates than unlisted space. The rationale for bringing parity between long-term capital gains tax (LTCG) for listed and unlisted securities is rooted in channelising domestic capital towards entrepreneurship.  The domestic capital scarcity in this industry is evident from the recent data published by SEBI: In 2023, 70% of the ₹2.4 Tn in VC/PE investments came from overseas. The share of domestic and foreign capital is 50/50 and the domestic pool is only 1/10th of the equity MF pool.  The burden on Indian investors willing to provide risk capital, needed easing.

Solution:

With the bunching of all financial assets with a uniform 12.5% LTCG (without indexation) in the budget, this disparity has finally ended. In addition, there is complete rationalisation of tenure with just two categories viz. 12m and 24M instead of three categories earlier. Earlier, the LTCG on unlisted investments was 20% (with indexation) which for a top-quartile performance fund which as per SEBI’s benchmarking data delivers 20% translates to ~15-16% effective tax rate. This has now been made 12.5% and the parity enables investors to make investment decisions solely based on merit.

The decision to harmonise capital gains tax across asset classes has a positive effect in three areas. One, it lowers arbitrage among asset classes, such as equities, real estate and gold for household savings. Two, it addresses the differential in effective tax rates on labour and capital. And, three, it allows government tax revenue to grow without unduly affecting economic productivity.
Of course, there are debates in the market on removing indexation for property transactions and increase in STCG and LTCG in listed space.

The biggest hit will be on foreign direct investments (FDI) in compulsorily convertible debentures (CCDs), where the income tax rate on capital gains has gone up to 35% from 10%. Earlier, gains on unlisted CCDs held directly by foreign companies for more than three years were treated as long-term capital gains (LTCG) and taxed at 10%. Now, these gains will be treated as short-term capital gains (STCG), regardless of the holding period.

5.Infrastructure

Importance on Capex for spurring investments is well known. Govt has been spending considerable amount on infrastructure during the past five years.

• Govt continued its commitment to infrastructure development by maintaining Capex at ₹ 11.11 lakh cr. – 3.4% of GDP which is 17% higher than FY 24.
• From FY27 debt to GDP ratio likely to be lower.

6. Space economy

Announcement of Rs 1000 cr. Venture Fund for supporting space economy is a right move. Close on the heels of successful sub orbital test flight in May 2024 of domestically manufactured 3D printed semi cryogenic rocket named Agnibaan by Chennai based space startup Agnikul Cosmos, has attracted eyes of the Government. Indian Space Sector is valued at $9.6 Bn and contributes 2%-3% of the global space economy.

We hope that the venture fund proposed would provide long term support and has adequate priority distribution model to encourage participation from commercial investors to achieve the 10% share of global space economy in 2030.

6. Other key announcements:

• The contentious equalisation levy of 2%—on digital companies, online education-providing firms, and software-as-a-service providers without a permanent physical presence in India—will be abolished. Its abolition will now likely lead to better tax compliance,
• The Government will introduce a Variable capital Company [VCC] regime to enable the pooling of private equity funds and provide a flexible and efficient mode for financing the leasing of aircraft and ships. This model would be highly beneficial for a private equity fund manager and would help him manage multiple sub funds with flexible options to investors.
• A proposed amendment to the Income Tax Act, under Section 194Q, allows loss-making companies, including startups, to obtain a certificate to avoid withholding 0.1% tax on payments exceeding ₹50 lakh for goods purchases. This change helps conserve working capital and manage cash flows better, eliminating the need for refunds due to withheld tax exceeding actual tax liability.
• The decision to support construction of 30 million additional homes under the Pradhan Mantri Awas Yojna, with an allocation of Rs 10 lakh crore towards 10 million homes in urban areas and the potential reinstatement of interest subsidies, is expected to support the affordable housing segment.
• So far, payment of consideration by a domestic company to a shareholder on buy-back of shares was taxable at 20% in the hands of the company. Hence forth, buyback to be taxable in the hands of the shareholders. For calculation of capital gains, the consideration shall be considered as “nil” and actual cost of acquisition shall be available, resulting in capital loss.
• Budget proposal to expand the scope of safe harbour rules and streamline transfer pricing assessment procedure would provide certainty in international taxation and “reduce litigation” for global IT firms operating in India can further spur the massive expansion of global capability centres (GCCs).

 

Key Highlights – Economic Survey

Indian Economy:

• GDP Growth: Real GDP grew by 8.2% in FY24, marking over 7% growth for the third consecutive year, driven by stable consumption and investment demand (agriculture: 18%, industry: 27%, services: 55%).
• Trade: Exports grew by 0.23%, while imports declined by 4.9% despite strong domestic demand. Service exports reached a record USD 341.1 billion. Current account deficit falls to 0.7% of GDP from 2.0% in FY23.
• Investment: Net FPI inflows were USD 44.1 billion in FY24, reversing net outflows from the previous two years. Net FDI inflows declined from USD 42.0 billion in FY23 to USD 26.5 billion in FY24, with gross FDI inflows moderating by only 0.6% due to increased repatriation/disinvestment.
• Going forward: India’s workforce is estimated to be nearly 56.5 crore in 2022-23, needs to generate nearly 78.51 lakh non-farm jobs annually. Achieving the 2070 net-zero target requires USD 1.4 trillion investment.
• R&D Progress: Nearly one lakh patents granted in FY24, up from less than 25,000 in FY20.

Industry:

• PLI Schemes: Outlay of ₹1.97 lakh crore led to ₹1.28 lakh crore investment, generating ₹10.8 lakh crore in production/sales, 8.5 lakh jobs, and ₹4 lakh crore in exports.
• MSME Contribution: MSMEs accounted for 35.4% of manufacturing output and 45.7% of exports in FY22.

Services:

• Global Services Export: India’s services exports constituted 4.4% of global commercial services exports in 2022.
• IT and Computer Services: Share of total GVA increased from 3.2% in FY13 to 5.9% in FY23.
• Global Capability Centres (GCCs): Increased from over 1,000 in FY15 to more than 1,580 centres in FY23, employing over 16.6 lakh people. Revenue from GCCs grew from USD 19.4 billion in FY15 to USD 46 billion in FY23. BFSI sectors collectively account for about 58 per cent of India’s IT GCC talent.
• ONDC: Recorded 68 million transactions and onboarded 5.3 lakh sellers, 85% of whom are small sellers.

 

Financial Services:

• Credit Growth: SCBs credit disbursal grew by 20.2% to ₹164.3 lakh crore by March 2024. Industrial credit growth was 8.5%.
• TReDS Platforms: Discounted 98.9 lakh invoices worth ₹2.9 lakh crore by March 2024.
• Asset Quality and Performance of SCBs: GNPA ratio declined to 2.8% in March 2024. RoE and RoA reached decadal highs.
• Primary Markets: Capital formation was ₹10.9 lakh crore, with IPOs increasing by 66% to 272, raising ₹67,995 crore.

Innovation and Private Capital:

• Tech Start-Ups: Increased from 2,000 in 2014 to approximately 31,000 in 2023, with roughly 1,000 new tech start-ups in 2023.
• DPIIT-Recognized Start-Ups: Over 1.25 lakh recognized start-ups, with 13,000+ in AI, IoT, Robotics, and Nanotechnology.
• Fund Management Entities and Funds: Registered FMEs and funds with IFSCA rose from 39 and 33 in September 2022 to 114 and 120 by March 2024.