Mr. FM - You just threw out the baby with the bath water

On budget day, Mr.FM has denied the nation the chance to fully utilize (and not exploit) the chance of being prudent debt market investors. The pain point is that he has increased the period considered for long term taxation to three years from one year. Any redemption from debt funds before three years will attract marginal taxation (30% for most investors). There is an increase in tax post indexation which investors can live with.

The reason given is that CBDT showed him the data that supports the view that it is the corporates who benefit from the tax arbitrage present between debt mutual funds and bank fixed deposits. He added that CBDT mentioned that very few individual investors benefit from it. Only a FM who does not have a single rupee in debt funds cannot realize the value of these.

I do not doubt the data analysis of CBDT but wonder why we have such a conclusion. Investors (I am not talking of HNIs living in Mumbai) have never understood debt funds. They have never been properly educated about debt instruments by their financial advisors and wealth managers. So much so that they get immensely confused if they are told that bond yields and bond prices move in opposite direction. Slowly but surely they were getting educated just when Mr. Subba Rao administered the bitter medicine of sharply increasing rates overnight last July. This shock had erased all the learning of the investors instantaneously. Compounding this, there was only a small percentage of people who invested in debt  market as the real rate of return was negative. The savings were channelled into Gold and Real estate.

Just when real interest rates were turning positive (on a consistent basis), did our FM threw out the baby with the bath water - in order to prevent profiting by corporates from tax arbitrage. He has destroyed an important tool available for individual investors to save with lesser risk. He has forced investors to take on vehicles of sub-optimal returns adjusted for risk. Individuals will invest in fixed deposits which give post tax returns of 6.3% if one is lucky, earning less than inflation. The enterprising advisors will convince them to invest (or punt) in equities as the sentiment is up and volatility is low. We will have yet another market where participation from FIIs will be to the brim and the individual investors will be completely absent. In any case, Mr. FM has made sure that the individual investors will never get a chance to learn how to invest in debt markets. Just when the mutual fund and wealth industries were coming out of woods, the blow has been dealt. Since significant chunk of asset size is in debt, the two industries will have to find new ways to plug the hole in their earnings. They have to work even harder to create investor interest in non-equity-non-debt funds like Gold funds (FoFs), Fund of Funds and International funds. Mr.FM! did you have to do it? Do you have to break it before fixing it, Yet again?