The biggest victim of the end of the Ltcg regime is not loan funds but the debt market

At the head of the losers is the tradition of the democratic budget, which involves a broad debate on tax proposals. The removal of this three-decade-old perk was brutally quick and secretive. Even the removal of benefits for market linked debentures of Rs 75,000 crore was mentioned in the 2023 budget speech and was discussed before and after the speech. However, that a tax advantage that impacts an asset class of Rs 20 trillion has been removed without any public debate is disappointing.

With regard to financial entities: the losers are of course funds invested less than 35% in Indian equities – these include many debt funds, gold funds, funds of funds and funds investing in equity markets strangers.

A look at the losers due to new

LTCG rules

– The largest category of victims are debt funds. But the entire Rs 20 trillion silver rupees in debt funds are unaffected because many would not be able to benefit from the current benefits of the LTCG anyway.

For example, overnight, liquid and very short-term funds have always been for companies that have been in these funds for a few weeks to a few months.

– Those that are really affected are target maturity funds and Bharat Bond ETFs as well as medium duration funds that invest on a three to five year maturity. These are the ones that retail investors, wary of stocks, have sought out as well as companies that have savings to spare. The mutual fund industry estimates that around Rs 4.5 trillion is invested in these funds.

Shares of asset management company MF such as HDFC AMC, UTI AMC and ICICI Prudential were sold on March 24 to reflect the likely loss of fees for these companies. On the contrary, bank stocks have gained hope that, since the end of the tax advantage enjoyed by MFs on bank deposits, banks will now be able to raise deposits more cheaply.

– The third category of losers is us – the risk averse investors in debt funds – more on that later

– The fourth category are debt issuers. Non-bank financial corporations (NBFCs) regularly issue two- to three-year debentures that are largely purchased by debt funds. It is possible that shadow banks will see a slight increase in the interest they now have to pay on their bond raising.

Similarly, NBFC PSUs like REC, PFC, Nabard and NHB are also large issuers of three to five year bonds. They too may need to increase their yields. The impact on returns may not be huge because the savings don’t come out of the economy. They can move debt funds to insurance or banks. Therefore, three to five-year bonds may see higher yields, but not 10-year corporate bonds.

– The biggest casualty is clearly the debt market since mutual funds were the only parties that bought and sold corporate bonds in the debt market. Insurance and pension funds and even banks are generally long-term buyers. Thus, the dynamism of the debt market will necessarily be compromised if the debt funds do not receive additional money.

Big companies also fear that the rules will force firms with more than Rs 10,000 crore exposure to banking systems to raise 25% of their additional debt through capital markets. But that will become difficult as the debt market may see buyers dwindle. Thus, India’s anemic debt market has further emaciated.

A word about the winners:

– Retail investors like you and me, who lost the tax advantage when investing in a debt fund, may be attracted to guaranteed return insurance products and even endowment funds. Some wealthy retail investors who are already paying premiums above Rs 5 lakh will not benefit from these insurance schemes. Additionally, retail investors who do not wish to keep their savings tied up too long may find the insurance option less attractive.

– The other beneficiary of the elimination of the debt fund’s tax advantage is widely considered to be bank deposits. However, personal finance experts say that not all migration to FDs may happen.

First, savings in an FD bank are taxed annually at the investor’s slab rate, but the same money invested in an MF is not taxed until the investor redeems their shares. Second, the gains of the debt fund may be offset by the losses of some other funds and therefore saving through the debt funds will have an advantage over the bank deposit.

The extent of damage to debt funds

– As we have already said, liquid and very short-term funds did not benefit from the drop in capital gains anyway. Even among target maturity and medium duration funds, it is unlikely that all companies will abandon debt funds, as the question arises: abandon and go where.

Yes, these companies could manage their cash internally. So far they have avoided this and put their money in a debt fund because of the tax advantage. But fund managers point out that for a company to manage its cash on its own, you have to invest in a whole team, something debt funds are willing to do for as little as 20 basis points, if you use a straight shot. According to these experts, many companies can continue to stick at least partly to debt funds and accept the higher capital gains tax when they sell.

– In the end, the biggest loser is not the debt fund but the growth of the Indian corporate bond market. The government can argue that despite three decades of tax exemptions, mutual funds have done very little to develop this market.

The total number of folios (i.e. investors) in the debt market stands at 71 lakh at the end of February, according to data from the Securities and Exchange Board of India (SEBI). From this, if one deducts the folios of overnight, liquid, ultra-short and low duration funds, the number of folios drops to less than 30 lakh. Hardly, a large number of investors by way of impact, the government can argue.

But the answer is not to throw in the towel. India needs a corporate bond market. The government and regulators need to sit down and think about ways to broaden and deepen the bond market. The government, in particular, needs to realize that losing a few thousand crores through capital gains tax is well worth paying to create this market. It is hoped that a redesign will occur.