The Union Budget 2012 has tried to attract small investors into the stock market leaving mutual funds in a mess. It shows knee jerk reaction, no understanding of ground reality and policy confusion

Finance Minister Pranab Mukherjee, in his budget presentation speech for the fiscal 2012-13, announced a slew of measures to encourage the small investor to participate in equity markets. Would these be effective or was the FM poorly advised about what his measures really mean? The budget proposals include:

•  Rajiv Gandhi Equity Scheme to deepen investor base and reduce volatility, allows for 50% deduction to the small investor, to an annual limit of Rs50,000 in equities. However, this will apply to only those investors up to Rs10 lakh income to be eligible for the scheme. Investment will also have to be locked-in for three years.
•   The Securities Transaction Tax (STT) on cash delivery transactions has been reduced by 20%, from 0.125% to 0.1%, in order to reduce transaction costs in the capital markets.
•   Additionally, the FM has modified IPO guidelines to broaden investor reach. To achieve this, it is mandatory for companies to issue IPOs of Rs10 crore and above in electronic form through nationwide broker network of stock exchanges.
•   The finance minister has also proposed a central Know Your Customer (KYC) depository will be developed in 2012-13 to avoid multiplicity of registration and data upkeep.

The overwhelming emphasis on the equity markets is a policy volte face, most likely a result of no organised thinking but a knee jerk reaction to the declining interest of savers in the equity markets. For the last 20 years, there has been a continuous emphasis on mutual funds as an effective tool for small investor participation and investment. Investors have been told not to trade in equities if they are not sure what they are doing. However, now the FM is offering incentives to small investors to buy equities while mutual funds have been effectively killed when the market regulator started messing around with commissions (starting with banning entry load and upfront commission in August 2009) under chairman CB Bhave, which the current chairman has perpetuated. Following this, many distributors have stopped selling mutual funds thus restricting their reach to small investors. And now, instead of fixing this problem, the government is instead pushing these investors from mutual funds back to equities without any debate.

The tax incentive for equity investment is also a not a well-thought out idea. We have been had 100% exemption long-term capital gains in equity investment (over one year) for years now and yet there has been little equity participation despite this huge benefit. What is the point of having a three-year lock-in period when long-term capital gains, which is totally exempt for capital gains over just a year is not being availed of? Merely locking in investors with the Rajiv Gandhi Scheme, for Rs50,000 tax benefit, is convoluted and has no logic. They might as well bypass the scheme altogether and invest in equities, where capital gains are tax-free. The government seems to have missed the point.

The reduction in STT for delivery trades, while welcome, would also not mean much. The bulk of volumes comes from speculation in futures and options. This minor tweak of reducing STT for delivery trades amounts to no incentive at all for non-investors and is unlikely to entice them to the stock market.

Why has the FM suddenly tried to bring small investors back into the market? After years of thoughtless policies, cumbersome regulations, poor grievance redressal and no course correction, India's investor population is declining.
Moneylife has been repeatedly pointing out that India's investor population has declined from 20 million in the 1990s to just over 8 million by 2009 (as per the D Swarup Committee report). All this while the regulators who live in the ivory tower were unconcerned about this phenomenon. Suddenly, the drought of new issues and the government's failure to disinvest easily has woken up policy makers (mainly the market regulator) to the sad state of stock markets. But since they have no truck with reality, the measures they have suggested to the FM would turn out to be meaningless.