Why the Left is right, but sort of wrong... - Views on News from Equitymaster

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks


Login Failure
(Please do not use this option on a public machine)
  Sign Up | Forgot Password?  

Why the Left is right, but sort of wrong...

May 22, 2006

Red was the dominant colour and theme across India for much of last week. The reality of the election results in four states in which the "reds" gained more power slowly began feeding its way into policy statements on how not to raise oil prices and to continue to subsidise a range of Indian oil consumers in a bizarre way. But red was also the colour of the victory flag as the Tata group announced that their revolutionary project for introducing a car that costs less than Rs 200,000 (USD 4,600) will be manufactured in a factory in West Bengal probably one of the longest communist-ruled areas in the world after China, Cuba, and North Korea.

Red was the colour of blood on Dalal Street as bulls, fabled to charge towards red, and seemed to run away from it in haste. And red were the comments made by the Communist Party when they challenged conventional perception and made some very intelligent comments on why India's capital markets needed a strategic re-think.

While a myriad of experts and commentators were looking for the usual suspects of vague tax circulars, vaguer hints of some ominous syndicate that was acting in concert to bring share prices down and impoverish the country for personal profit, littered with some panic-stricken statements on how the heavens were falling. (Did anyone ask for an investigation when the market was galloping ahead? Human nature, I guess everyone loves wealth creation irrespective of how and why.) But while the witch-hunting and shadow-boxing was gamely on display, the Communist Party of India (Marxist) broadly said that the recent rout in the stock markets in India was due to global factors. Spot on!

The CPI (M) then went on to say that India should start taxing capital gains and suggested that this Double Taxation Agreement treaty with Mauritius should be revamped. Capital gains taxes, said the CPI (M), are charged by other countries and capital still flows in, so why should India not have this tax on capital gains? The capital gains tax was recently reduced to zero from 10% on long-term gains (securities held for more than one year) and to 10% from 30% for short-term capital gains.

Well, the left is sort of right but wrong on this one. India must have a tax regime that suits its objectives. On the assumption that the CPI (M) wants a better life for its comrades, India will need to build more power plants, more roads, more schools, and more hospitals for our growing population over the next few decades. And that will cost hundreds of billions of dollars which cannot be financed from domestic savings. So, whether we like it or not, we need to use external capital for this massive build-out to make every comrade's life a lot better.

Now the key question: what kind of money should we attract? The answer: patient, long-term money to build long-term infrastructure and businesses. And this is where there has been, in my humble opinion, a policy disconnect.

The fact is that there is over US$ 16 trillion (some 20x India's annual GDP) with the pension funds of the developed world and India needs probably 5% of that over the next decade. But that money takes time to come to India and it needs to see regulations that seem steady and sensible for attracting their money. There is another pool of money often referred to as "hedge fund" money but, basically, in common parlance it means anyone looking for a quick buck in the quickest period of time before they make a quick turnaround to their next destination for another quick buck. Most policymakers in India do not seem to recognise the whimsical nature of the money that comes in from hedge funds and shorter-term pools of money via the P-Notes versus the longer-term nature of money that could come in from the pensions and endowments. On visits overseas they meet hundreds of fund managers many of whom have an investment time-span of weeks and tend to rarely interact with the real source of money: the pension funds and endowments.

The pension funds are owned, the CPI (M) will be happy to note, not by any individual but by the workers of companies, many of whom belong to unions - comrades from different nationalities, but union workers nonetheless. And these pools of pension money are given a tax-free status in their home countries just like our PPF that is tax free for our comrades in India.

Keeping in mind the steadier nature of the pension fund money and the more fickle nature of the hedge fund money, our policy makers should come up with a tax structure that rewards long-term risk-taking and punishes short-term fickleness. A simple way to do this would be to make all capital gains from investment in shares free of tax but to tax the investors a high, say 2%, transaction levy on the value of any stock sold within a year. There was an attempt to move to a two-tiered structure via a dual Securities Transaction Tax in July 2004 but the powerful influence of brokers who were nervous that their clients would trade less (the higher the volume, the higher the commissions the brokers make) forced the government to roll back its "discrimination" against short-term traders.

Purists and theoreticians, reading this will be bristling at the hindrance to "price discovery" establishing a price on as high a volume as possible. But, hey, we have just seen some pretty good "price discovery" last week. Massive mood-swings of short-term capital leads to these sort of boom-bust cycles that actually scares away the long term pension money. There is a risk that they will brand the Indian stock markets as too volatile for their objective of trying to seek steady, safer, long-term returns. Whether we like it or not: we need the foreign comrades to help our own comrades in India. The Reserve Bank of India had given a dissenting note on the recently submitted report led by Mr. Ashok Lahiri on the framework for capital market flows into India. The Reserve Bank of India (RBI) was rightly concerned about the longevity of the source of money being used to buy Participatory Notes (as an aside, these are also very profitable for the brokers) and the potential for havoc like the little tremors we just felt last week.

The CPI (M) is right: India fell as much as many global markets last week probably due to the jumpiness of the shorter-term pools of capital from within India and from overseas. If we had more long-term money in India, the fall would probably have been less than global markets but neither would we have had that spectacular increase since May 2005. Doing away with the Mauritius route or increasing capital gains tax is not the prescription for the stock markets recent pain. Preventing shorter-capital flows by tweaking their transaction rates and setting policy for accepting longer-term money is a better solution. The comrades in India will get the money they need from their comrades in the developed world. That would, indeed, be a red-letter day for the development of India.

This article is authored by Ajit Dayal is the founder of Quantum Advisors, an investment advisory firm that focuses on long-term investing for long-term investors. The views expressed here are his own and not necessarily that of the organisation. Quantum Advisors is also the sponsor of Quantum Asset Management Company Private Limited. You can visit their web site at www.quantumamc.com

Equitymaster requests your view! Post a comment on "Why the Left is right, but sort of wrong...". Click here!


More Views on News

BSE Sensex Surges 600 Points; BAJAJ AUTO Among Top Gainers (Market Updates)

Oct 1, 2020 | Updated on Oct 1, 2020

The BSE Sensex Surged 600 Points; BAJAJ AUTO Among Top Gainers. Find the latest update, special reports and news on all time high gainers of BSE Sensex at equitymaster.com.

You Should Be looking for Small-cap Stocks that Will Rebound Strongly (Profit Hunter)

Oct 1, 2020

This single trait in excellent small cap businesses differentiates them from the rest.

This Number Will Give You an Edge Over Other Traders in the Market (Fast Profits Daily)

Sep 30, 2020

In this video, I'll share with you, a crucial number that I track everyday which gives me trading edge.

Is Mirae Asset Ultra Short Duration Fund a Right Solution for Your Short Term Needs? (Outside View)

Sep 30, 2020

PFN explains about the Mirae Asset Ultra Short Duration Fund.

India's Drone Revolution is a 4x Profit Opportunity (Profit Hunter)

Sep 30, 2020

My research on India's leading defence companies brought me to one major player in drone manufacturing.

More Views on News

Most Popular

My Top Stock to Buy in this Market Selloff (Profit Hunter)

Sep 22, 2020

The recent correction offers a great opportunity to buy this high conviction smallcap stock.

Can the Nifty Fall to 10,200? (Fast Profits Daily)

Sep 24, 2020

The Nifty has reached an important support level today. If it breaks then we could see further downside.

What Do the Charts Say About Buying Smallcaps Now? (Fast Profits Daily)

Sep 18, 2020

Everyone seems to be excited about buying smallcaps now...but is it the right thing to do? What do the charts tell us? Find out in this video...

I Believe These Stocks Will Deliver the Most Outsized Returns in 2021 and Beyond (Profit Hunter)

Sep 23, 2020

Rules of the racetrack can help you bag the biggest gainers of the coming decade.


Covid-19 Proof
Multibagger Stocks

Covid19 Proof Multibaggers
Get this special report, authored by Equitymaster's top analysts now!
We will never sell or rent your email id.
Please read our Terms


Oct 1, 2020 01:01 PM