[Updated on 14 Aug 2019]
Everyone is asking two questions “What actually happened to the market that it had to eat all the gains of 2019?” and “why only Indian Market didn’t perform since May 23, 2019, while others did?”.
Let me try to to make it simple to understand.
There are 9 major reasons why the market is down and volatile.
1.The proposals to increase the tax on the super-rich, including foreign funds.
2.The proposal to tax share buybacks by listed companies.
3. Increase the minimum public shareholding requirements to 35% from 25%.
5.Detection of a fresh loan fraud at Punjab National Bank.
6.Disappointed Fed outcome
8.The trade war between US and China.
9. Yuan devaluation.
Let me explain it- One by one.
1) Increase Taxes on FPIs
The government in the recent budget proposed an increase in the tax surcharge for foreign entities which are registered as non-corporates.
•For an FPI reporting earning between Rs. 2 crore and Rs. 5 crore, the effective tax on derivatives goes up from 35.88% to 39%.
•For an FPI reporting earning over Rs. 5 crore of income in India, the effective tax rate in derivatives goes up from 35.88% to 42.74%.
“Some FPIs are registered as trusts. Therefore as an individual entity, he comes under the taxation. Such FPIs who have registered themselves as trusts may consider the option of wanting to move to register as the company” — Nirmala Sitharaman, FM, India
While increasing the surcharge, government included all the individuals and registered as Trust. Many foreign portfolio investors (FPIs) are structured as AOPs, limited liability partnerships, and trusts. Hence, they will be subject to the higher tax surcharge if they earn over Rs 2 crore of income a year.
Why are many FPIs unable to shift from a trust structure to corporates?
The government has been maintaining a stance that FPIs wanting lower tax outgo should convert themselves into corporates. However, it is not possible for the FPIs to convert themselves from trusts to corporates overnight especially in the wake of the anti-tax avoidance laws. Some of them may have the option to create a new corporate entity and route all their fresh investments through the entity to avoid higher tax outgo.
•Not all FPIs will be able to undertake such restructuring due to several factors including restrictions in the laws applicable in their home countries.
- A single FPI entity set-up invests in multiple markets. Hence, they might not be able to restructure themselves as corporates just for Indian markets, because such an exercise could have repercussions in other markets they are investing in
Sitharaman had a meeting on Friday (9 Aug 2019) with 18 global investment banks to discuss the controversial tax Sources said Sitharaman gave no indication that she would withdraw a proposal to raise their taxes. But at the meeting with foreign investors, Sitharaman “only heard us and did not speak,” according to two foreign portfolio investors who attended the meeting.
1) Rs 15,00,000 cr gone in 30 days as blue chips bear brunt of FII selloff.
2) BSE’s total market capitalisation has fallen 10% to Rs 138 lakh crore from Rs 153.58 lakh crore on July 5. Sensex has fallen 8% during the same period.
3) India exits $2 trillion m-cap club after sell-off by FPIs.
4) Eight of the 10 most valued Indian companies saw a combined loss of Rs 89,535 crore in market valuation in the week-ended August 2.
5) Indian stocks suffer worst July in 17 years.
2) Tax on share buybacks
Finance Minister Nirmala Sitharaman in her maiden Budget, proposed to levy a tax on at 20% buybacks by listed companies. Previously buyback tax was applicable only for unlisted companies.
What is Buyback? A buyback essentially is a scheme by which a company repurchases a certain amount of its outstanding shares. Once taken back, these shares are extinguished by the company.
•In 2018–19, as per official data, 60-plus companies went in for buybacks, including large IT companies such as TCS, HCL Tech, Tech Mahindra, besides ONGC, BHEL, Oil India, Coal India and NMDC.
After FY16–17, buybacks became more popular as dividends amounting to more than ₹10 lakh were made taxable in the hands of shareholders (at the rate of 10%).
Buyback tax coupled with dividend tax will lower the expected payoff from equity and its multiples. Such high level of taxation will lead to companies retaining more of their earnings which has potential risk of driving down RoE and can also lead to sub-optimal reinvestment in the business or unrelated/loosely related diversification and increase governance risks.
3) 35% Minimum Public Shareholding
Finance Minister Nirmala Sitharaman has asked the market regulator Securities and Exchange Board of India (SEBI) to consider raising the current thresold from 25% to 35%.
Why it is dangerous?
•Some of the most valued companies in India like TCS, Wipro may offload shares worth Rs 75,000 crore if public shareholding rises to 35%. Tata Sons owns 72% in TCS, while the Premjis hold more than 73.8% in Wipro.
•L&T Technology Services has a promoter holding of 78.8% and would have to dilute shares worth over Rs 2400 crore. Other companies that may be hit include Quick Heal Technologies, Take Solutions, Datamatics Global Services, Accelya Solutions India, Axiscades Engineering Technology, Nucleus Software Exports, Newgen Software Technologies, all of which have a promoter holding of more than 65%.
This rule may result in equity sales of about 3.9 trillion rupees ($57 billion).
4) Foreign outflows
As of August 2, FPIs have been net seller of over ₹20,500 crore worth of stocks on the BSE, NSE and MSEI in the capital market segment, since 1 July.
•Prior to this, FPIs infused a net ₹10,384.54 crore in June.
5) Fresh fraud in PNB
On July 06, PNB disclosed it has detected a fraud of more than Rs 3,800 crore by Bhushan Power & Steel (BPSL) and has reported it to the Reserve Bank of India (RBI).
•PNB said Bhushan Power & Steel misappropriated bank funds and manipulated its books of accounts to raise funds from consortium lender banks.
•The exposure of Rs 3,800 crore includes domestic exposure of Rs 3,200 at its Chandigarh branch, overseas exposure of Rs 345 crore at the bank’s Dubai branch and Rs 268 crore at its Hong Kong branch
6) Disappointed Fed outcome
The first cut in more than a decade, was widely expected. But the stock market sold off aggressively after Powell said during a news conference that the move was just a “mid-cycle adjustment,” which traders took to mean this is not the start of a longer-term easing period.
- “What the Market wanted to hear from Jay Powell and the Federal Reserve was that this was the beginning of a lengthy and aggressive rate-cutting cycle which would keep pace with China, The European Union and other countries around the world,” : Trump
The US Fed cut policy rate by 25 basis points overnight and Markets took it as a sign that sharp further cuts were not imminen later powell said this move was not the beginning of a long series of rate cuts.
7) Weak Rupee
On Aug 05, Rupee suffers the biggest fall in six years against US dollar.
•The rupee fell to 70.74 against the US dollar, as compared to its previous close of 69.60 a dollar — its biggest one-day fall in nearly six years.
•A weak rupee eats into the takeaway profit of FPIs and hence make investment unattractive.
•Whenever rupee falls/depreciates FIIs avoids investing in India.
8) Trade War (US-China)
On Aug 02, US President Donald Trump has said he will impose a fresh 10% tariff on another $300bn (£247bn) of Chinese goods, in a sharp escalation of a trade war between the two countries.
•The US launched an investigation into Chinese trade policies in 2017. It imposed tariffs on billions of dollars worth of Chinese products last year, and Beijing retaliated in kind. Both countries agreed to halt new trade tariffs in December to allow for talks. But hope for a deal faded, and further tit-for-tat tariffs were imposed.
- A truce agreed last December collapsed and in May the US raised tariffs on $200bn of Chinese products to 25% from 10%. Again China retaliated with tariff on $60bn of US goods.
9) Currency Manipulation:
Scarily, president Donald Trump doesn’t seem to have a clear idea of how foreign trade works or even what his ultimate objective is and how to achieve it. He’s dragged the U.S. into a trade and currency war that has no end in sight. Key U.S. stock indexes fell almost 3% on Aug. 5 after the yuan’s depreciation.
For the first time in more than a decade, Beijing let the yuan weaken past the symbolically important level of 7 to the dollar on Monday.
It comes days after US President Donald Trump said he would impose a 10% tariff on $300bn ($246bn) worth of Chinese goods, effectively hitting all of China’s imports to the US with duties.
Q: What is the impact of a weaker yuan?
A: China’s economy depends significantly on its exported goods. By devaluating its currency, the Asian giant lowered the price of its exports and gained a competitive advantage in the international markets. A weaker currency also made China’s imports costlier, thus spurring the production of substitute products at home to aid the domestic industry.
President Donald Trump has bragged repeatedly, in tweets and press conferences, that China is absorbing the cost of U.S. tariffs on Chinese products.
Q: Why is currency manipulation so controversial?
A: Currency manipulation — by China or any other country — is seen to flout global trading rules by conferring unfair competitive advantages. The country does so by artificially inflating or deflating its exchange rate. It may be designed to make exports more competitive, to avoid inflation or reduce capital inflows.
Currency manipulation has “serious effects on the global market”.
Let’s unpack the yuan’s depreciation, which amounts to nearly 5% since April. Any goods priced in yuan have become cheaper in dollars. The yuan depreciation seems to meet Trump’s requirement of making tariffs painless to American consumers. By reducing the yuan’s buying power relative to the dollar’s, it makes the Chinese poorer and Americans richer. For Trump, though, this is highly problematic. The depreciation will make it easier for China to hang on to its market share in the U.S. As a result, Trump could fall short of his oft-stated goal of bringing factory jobs back to the U.S. on a massive scale.
The most important number in the financial world for the next few weeks will be the dollar-yuan exchange rate. On Aug. 6 the People’s Bank of China took a step back from confrontation. It set its daily fixing for the yuan at under 7 to the dollar (the fewer yuan it takes to buy a dollar, the stronger the Chinese currency is). It also announced plans to sell yuan-denominated bonds in Hong Kong, which would soak up yuan held outside the country and make it harder for traders to borrow the currency to short it — i.e., bet on further declines.
Trump is right to worry about a weaker yuan. Even though it shields American consumers from higher prices, it makes American goods more expensive in China, hurting U.S. exporters. For China, a weak yuan can be a strong weapon. Trump might have been happier if China, rather than letting its currency fall, had simply cut prices, destroying profitability. But that was never a realistic scenario.
While the trade war is turning out badly for almost all American exporters, it’s especially bad for farmers because China has halted purchases of U.S. farm goods in retaliation for Trump’s announcement of 10% tariffs on $300 billion worth of Chinese imports starting Sept.
Source: CNBC, Bloomberg, ET
Hope it was helpful and informative.
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