A Tax With Potential Side Effects – NBC New York

This report is from CNBC’s Inside India newsletter this week, which brings you timely, insightful news and market commentary on the emerging powerhouse and the big companies behind its meteoric rise. Like what you see? You can sign up Here.

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In 1696, King William III of England introduced a radical new tax on his subjects to increase the state’s revenue: by decree, every family in the country was to pay a tax based on the number of windows in their house. Typically, this meant that the larger the house, the higher the tax due.

Despite its progressive intentions, the tax failed to generate enough revenue for the monarchy, as people boarded up their windows to reduce their tax obligations. In the long run, the policy was a negative for the state, which had to fight epidemics of typhus, smallpox, and cholera resulting from the lack of ventilation.

So what does the window tax have to do with India today?

Earlier this week, India’s finance minister surprised markets with a measure she said would “deepen the tax base.”

Nirmala Sitharaman, while presenting her seventh Budget, raised the tax on trading in futures and options to 0.02% and 0.1% respectively — a 60% increase. The minister also raised the capital gains for stock market investors who cash in their capital gains within a year from 15% to 20%. Long-term investors will also pay a revised rate of 12.5% ​​on gains, up from 10%.

Taking a leaf out of 17th-century England, India’s finance ministry hopes the tax will change behaviour and stem an “uncontrolled explosion” in the derivatives market, where retail investors account for 41% of total trading volume.

The government may be concerned about the attempt to reduce the tax burden on stock traders rather than move away from gambling and its unintended negative consequences.

For now, the tax hikes appear to be overshadowing many of the positives that emerged from the budget. Foreign investors liquidated nearly $1 billion worth of Indian stocks in the two days since the budget was announced, and investors have been pushing down stock prices every day since.

“The lack of populist spending is in line with our expectations, although the capital gains tax hike on equities defies our expectation that nothing will change,” Upasana Chachra, Morgan Stanley’s chief India economist, said in a note to clients immediately after the budget announcement.

Will the government achieve its goal with the tax, even if investors ignore the initial pain?

“The increase in short-term capital gains tax from 15% to 20% will discourage excessive trading activities, while the increase in long-term capital gains tax from 10% to 12.5% ​​will negatively impact the market in the short term,” said Siddhartha Khemka, head of retail research at brokerage Motilal Oswal.

Not everyone is convinced.

“This may help defuse some of the more speculative nature of the market, but it is unlikely to put off retail investors in a meaningful way,” said Michael Langham, emerging markets economist at British asset manager Abrdn. “The move can be seen as part of a broader effort by regulators to contain some of the financial stability risks building up in equity markets, and it is not far-fetched to imagine further measures to contain some of the risks for retail investors.”

In fact, the risk to regulators may actually be inspired by modern Britain.

The UK introduced a transaction tax on every transaction in 1974. Although the tax raises more than £3 billion ($3.9 billion) a year, it has encouraged much riskier forms of speculation while negatively impacting the stock market.

Spread betting and contracts for difference (CFDs), which expose traders to much higher levels of potential loss – as well as gain – have flourished since the 1990s. Because neither product involves owning shares, turnover tax is bypassed entirely.

According to the Institute of Fiscal Studies, the tax also plays a role in undervaluing highly profitable British companies.

However, given the high equity valuations on Indian stock exchanges, a tax aimed at collecting surpluses could prove to be a positive solution in the long run.

I need to know

India likely to ease restrictions on some Chinese investments. Restrictions are likely to be lowered on investment in non-sensitive sectors such as solar panels and battery production, where India has no experience, according to news agency Reuters. The plans are a first step toward improving economic ties between the two neighbors, a relationship that deteriorated after clashes on their remote Himalayan border in 2020.

India “definitely has a problem,” says JPMorgan’s Jahangir Aziz. The chief emerging market economist believes India needs to find new drivers of growth, even if it is growing rapidly. “It will be very difficult for India to maintain a growth rate of 6% to 7% just in public infrastructure and services exports,” Aziz told CNBC.

Outbreak of a deadly virus. Health authorities in the southern Indian state of Kerala are on high alert following the latest outbreak of the deadly Nipah virus, after a 14-year-old boy died from the infection over the weekend. First identified in Malaysia 25 years ago, Nipah has an estimated mortality rate of 75% and has been cited as having the potential to trigger another pandemic.

What happened in the markets?

Indian stocks have fallen for five days in a row. The Nifty 50 index is down 0.65% this week, even as the benchmark is up 12.1% this year.

The yield on India’s 10-year government bond fell slightly to 6.95% after the government lowered its deficit forecast for this year from 5.1% to 4.9% of GDP.

On CNBC this week, Raghuram Rajan, former governor of the Reserve Bank of India, said the country needs to invest in education and skills to attract investment in sectors that generate more value.

“If you look at the budget, again you have to worry about huge spending on infrastructure and much less spending on building human capital,” he told CNBC.

Meanwhile, Suman Bery, vice-chairman of Niti Aayog, an Indian government public policy think tank, said it would be “slightly off-base” to assume that the budget unveiled this week is a consequence of the 2024 election results.

“India is creating jobs, but they are low-productivity jobs, and the only way to accelerate India’s growth is to transfer the demographic dividend—the labor force—to higher-productivity jobs, and that will require all sorts of structural changes,” Bery said.

What will happen next week?

US tariffs on several Chinese imports go into effect next week. On the data front, several central banks are set to release key decisions.

July 26: US Core Inflation

July 30: Japan’s unemployment rate, Eurozone GDP, Germany’s inflation

July 31: US interest rate, eurozone inflation

August 1: UK interest rate