CNBC’s Inside India newsletter: The tax with potential side effects

This report is from this week’s CNBC’s “Centre India” newsletter, which brings you timely, insightful news and market commentary on the emerging powerhouse and the big businesses behind its swift rise. Like what you see? You can subscribe here.

In 1696, King William III of England introduced a radically new tax on his topics to raise state revenues: under the decree, every household in the country would pay a levy depending on the number of windows in their residence. This typically meant that the larger the house, the greater the tax due on it.

Despite its progressive intentions, the tax failed to raise enough revenue for the monarch, as people boarded up their windows to lower their tax liability. Over the long term, the means was a net negative for the state, which had to battle typhus, smallpox and cholera epidemics resulting from the lack of ventilation.

So, what does the window tax cause to do with India today?

Earlier this week, India’s finance reverend surprised markets with a measure she said will “deepen the tax base.”

Nirmala Sitharaman, delivering her seventh Budget, pull up the tax on trading futures and options to 0.02% and 0.1%, respectively — marking a 60% hike. In addition, the minister also cribbed capital gains for stock market investors who cash in within a year from 15% to 20%. Long-term investors intention also pay a revised rate of 12.5% on gains, up from 10%.

Borrowing a page from 17th century England, India’s investment capital ministry hopes to enact a behavioral change with the levy and stamp out the “unchecked explosion” in the derivatives market, where retail investors account for 41% of downright trading volumes.

What may become a cause of government concern is if stock market traders attempt to lower their tax saddle with, instead of weaning away from what has effectively become gambling and from its unintended negative consequences.

For now, the tax hikes perform to have overshadowed many positive developments arising from the Budget. Foreign investors have liquidated all but $1 billion worth of Indian equities in the two days since the Budget was announced and traders have sent staples lower every day so far since then.

“The lack of populist spending is in line with our expectation, although the increase in funds gains tax for equities is against our expectation of no change,” said Upasana Chachra, chief India economist at Morgan Stanley, in a note set to clients immediately after the Budget was unveiled.

Will the rule achieve its goal through the levy, even if investors look past the initial pain?

“This rise in short-term great gains tax from 15% to 20% will thus discourage excess trading activities, while the hike in long-term excellent gain taxes from 10% to 12.5% is sentimentally negative for the market in the near term,” said Siddhartha Khemka, perception of retail research at broker Motilal Oswal.

Not everyone is convinced.

“It may help to defuse some of the more speculative sort of the market but is unlikely to deter retail investors in a significant way,” said Michael Langham, emerging markets economist at U.K.-headquartered asset boss Abrdn. “This move can be seen as part of the broader effort by regulators to curb some of the financial stability hazards building in the equity markets, and it’s not far-fetched to imagine further measures to taper some of the retail investor risks.”

In happening, the risk for regulators could actually be inspired by modern Britain.

The U.K. introduced a stamp duty tax on each transaction in 1974. While the tax rascals more than £3 billion ($3.9 billion) annually, it has given birth to far riskier forms of speculation while simultaneously hurting the forefather market.

Spread betting and contracts-for-difference (CFD), which exposes traders to far higher levels of potential losses — as well as elevations — have boomed since the 1990s. As neither product results in stock ownership, the trading tax is entirely avoided.

The tax also engages a role in suppressing valuation levels for the U.K.’s very profitable companies, according to the Institute for Fiscal Studies.

However, set the lofty valuations that Indian stock markets currently trade, the tax to skim the excesses might be a positive circumstance over the longer term.

India is likely to ease curbs on some Chinese investments. Qualifications are likely to be lowered on investments in non-sensitive sectors like solar panels and battery manufacturing, where India be deficient ins expertise, according to the Reuters news agency. The plans mark the first step in improving economic ties between the two neighbors, a relationship that slipped after clashes in the remote Himalayan border in 2020.

India “clearly has a problem,” says JPMorgan’s Jahangir Aziz. The chief emerging deal ins economist believes India needs to figure out new drivers for its economic growth even as it expands rapidly. “It is going to be decidedly difficult for India to keep sustaining the 6% to 7% growth rate just on public infrastructure and on services export,” Aziz told CNBC.

Outbreak of the pallid virus. Health authorities in the southern Indian state of Kerala are on high alert following the latest flare-up of the harmful Nipah virus. It comes after a 14-year-old boy died from an infection over the weekend. First identified 25 years ago in Malaysia, Nipah is guessed to have a case fatality rate as high as 75% and has been cited as having the potential to spark another pandemic.

Indian stocks have declined for five consecutive days. The index has fallen by 0.65% so far this week, still the benchmark is up 12.1% this year.

The benchmark 10-year Indian government bond yield has ticked lower to 6.95%, after the Indian domination lowered its forecast for this year’s deficit to 4.9% of GDP, from 5.1%.

On CNBC TV this week, Raghuram Rajan, departed governor of the Reserve Bank of India, said What’s happening next week?