Indian markets have come-off a great deal in the last few weeks, since the announcement of the Union Budget 2019.
Selling by Foreign Portfolio Investors (FPI) has been one of the prime reasons for the fall. Since July 1, 2019, Foreign Portfolio Investors have net sold in the Indian markets to the tune of Rs 6,475 crores. While domestic institutions have cushioned the markets fall, by constant buying, there maybe a limit to which they maybe able to absorb the fall.
The biggest reason for the FPI selling
One of the biggest reasons for the FPI selling was the increase in tax surcharge on the such super-rich tax payers who earn more than Rs 2 crore a year. While increasing the surcharge, government included all the individuals and association of persons(AOPs) under the purview of the increased surcharge. Several FPIs are structured as Association of Persons, 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.
For a Foreign Investor reporting over Rs 5 crore income in India, the tax rate goes up from 35.88 per cent to 42.74 per cent. If the same entity is earning between R 2 crore and Rs 5 crore, the effective tax goes up from 35.88 per cent to 39 per cent. The only way for FPIs who are registered as individuals or AOPs, trusts and limited liability partnerships the option is to convert themselves into a corporate. That is far more complicated and hence FPIs may just chose to exit.
The effective tax rate of nearly 7 per cent in some cases, means the FPIs would need to earn substantially higher, to really make returns. Given that Indian markets are trading at substantial premiums to long term average, returns are likely to be mediocre. Unless, there is a big fall in the markets, things may not look attractive for FPIs and domestic investors alike. How much sales they will press is difficult to tell. For the time-being, it's a wait and watch approach.