Tuesday's Talking Points
Why Invest for Longer Tenures in Debt Funds before March 31, 2023?
As per the proposed amendments in the Finance Bill, 2023, income from any mutual fund investing not more than 35% of its total proceeds in the equity shares of domestic companies, shall be treated as short term capital gains.
The implications of this proposed amendment are as follows:
- Any investor investing on or after April 1, 2023 in the type of mutual funds specified above will not be able to take the benefit of cost indexation and concessional long-term capital gain tax rates
- The capital gains on such investments will be taxed at the investor’s corresponding personal income tax rate
The proposed amendment has been approved by the Lok Sabha and Rajya Sabha. After the Hon’ble President of India’s assent, it will become the Finance Act, 2023 and will be incorporated in the Income Tax Act, 1961.
The timing of this tax reform is crucial for debt mutual funds, as the interest rates have risen significantly in the recent past, making a case for investing in debt mutual funds before March 31, 2023.
While the yield curve appears flat, there is also a case wherein investors can invest for longer tenures as we may be near the peak of the current interest rate cycle. By virtue of this, investors can also take benefit of cost indexation over a long time period.
Source: Bloomberg, Current: March 27, 2023
On the Global Front...
Despite the Federal Open Market Committee (FOMC) hiking the US Fed Funds Rate by 25 bps on March 22, 2023, the recent series of events (failure of two regional banks in the US) have unexpectedly changed the outlook for Fed’s interest rate path. While earlier, the rate was expected to peak at 5.5-5.75%, and stay there for entire Calendar Year (CY) 2023, currently, as per Bloomberg, it is expected that the peak has not only been reached, but also has swung to a cut of ~90 bps by end-CY2023.
…However, India remains resilient
Firstly, there seems to be limited risk of similar event happening in India considering the stringent regulations around liquidity coverage ratio, Held-To-Maturity (HTM) investment proportion and capital adequacy requirement. Secondly, Indian banking system has gone through a multiyear clean-up exercise prior to the pandemic, and the current balance sheets are in significantly healthy shape with overall Net Non-Performing Asset (NPA) at ~1.3% and Capital Adequacy ~16% as on September 30, 2022.
While the Monetary Policy Committee is yet to consider the ongoing developments in April 2023, RBI has already conducted an effective tightening of 300 basis points (bps) with 250 bps of Repo Rate hike and draining of surplus liquidity. Thus, in a highly uncertain global environment there is a strong case for RBI to pause the rate hiking and wait till June 2023 to decide upon future course of action. Notably, by that time, there will be more clarity on progress of monsoon, impact of conducted rate hikes, direction of US Fed, and impact of aforesaid events on global growth and inflation.
Why Invest for Longer Tenures in Debt Funds?
Despite the uncertainty around global growth, India looks to be structurally stronger. Furthermore, with RBI being close to peak rate and the absolute level of yields being elevated across the board,there is a strong case for investors to increase investment for longer duration in debt funds.
Given the proposed amendment in taxation, this case becomes even stronger. Hence, it is the time for investors to invest before March 31, 2023, in order to not only invest for long periods, but also avail tax benefits of cost indexation!
Sources: Bloomberg, Federal Reserve, Reserve Bank of India, Lok Sabha, and other publicly available information
About Tuesday’s Talking Points (TTP): TTP is an effort by HDFC AMC to guide key conversations in the Indian financial markets and investing ecosystem. We aspire to do this by providing relevant facts, along with our perspective on the issue at hand. If you have a topic that you would like to be featured here, or in our Monthly Musings newsletter, please write to us at [email protected]
Disclaimer: Views expressed herein, involve known and unknown risks and uncertainties that could cause actual results, performance, or events to differ materially from those expressed or implied herein. Stocks/Sectors/Views referred are illustrative and should not be construed as an investment advice or a research report or a recommendation by HDFC Mutual Fund (“the Fund”) / HDFC Asset Management Company Limited (HDFC AMC) to buy or sell the stock or any other security. The Fund may or may not have any present or future positions in these sectors / securities / commodities. The Fund/ HDFC AMC is not indicating or guaranteeing returns on any investments. Readers should seek professional advice before taking any investment related decisions. Fiscal rules are subject to change. In view of individual nature of tax consequences, each investor is advised to consult his / her own professional tax advisor.
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