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Tax No Hurdle to India Stock Funds as Local Flows Accelerate

(Bloomberg) -- Investors in Indian equity funds are keeping faith, unfazed by a planned tax on stock holdings, a bank fraud scandal and turmoil in global markets.

Equity funds took in 163 billion rupees ($2.5 billion) in February, after pulling 154 billion rupees in January, data from the Association of Mutual Funds in India show.

Tax No Hurdle to India Stock Funds as Local Flows Accelerate

Investors held their nerve even after the government’s decision on Feb. 1 to impose a tax on equity gains and dividends from stock funds, a move that coincided with the selloff in markets from the U.S. to Japan. The liquidity has provided a buffer against outflows sparked by the risk-off mood: mutual funds bought $2 billion of shares last month, countering sales of $1.9 billion by their global peers.

“Going by the way things are, 2018 looks to be a bumpy ride and equities will need this support,” said Andrew Holland, chief executive officer at Avendus Capital Ltd. in Mumbai.

A widening probe into the $2 billion fraud that engulfed state-run lenders and worries over a global trade war sparked by U.S. President Donald Trump’s threat to impose tariffs dragged Indian stocks to a three-month low this week. Continued support from local funds will lend markets a cushion, Holland said.

There was concern that a move to end the tax break on equities would affect flows from retail investors, who’ve flocked to mutual funds since Prime Minister Narendra Modi took office in 2014. The influx of cash has been aided by policy changes, including the currency clampdown in 2016, which hurt returns from property and gold, the traditional favorites.

“There aren’t many options that can give decent returns but stocks,” Vidya Bala, head of research at FundsIndia, said by phone. “Retail investors are not going to pull out from equity funds unless there’s a prolonged correction. It has been proven that they can digest short-term declines.”

Some takeaways:

  • Local stock funds received 1.64 trillion rupees of net inflows in the first 11 months of the year that began April 1, more than double those of the year-earlier period: AMFI.
  • Inflows into balanced funds, which buy stocks and bonds, fell to 50 billion rupees in February from about 77 billion rupees in January, the data show.
    • The reduction was anticipated as “these funds are packaged in a way as to entice fixed-income investors through monthly dividend options. The budget imposed a 10% tax on dividends distributed by equity funds,” CLSA India Pvt. said in note.

While the full impact of the capital-gains tax on the sustainability of flows would be best gauged in the next couple of months, the February data is “reassuring,” CLSA said.

“We believe that the $25 to $30 billion -- 5 to 6 percent of annual household savings -- of domestic inflows into equities should easily sustain and are also needed given the large equities supply,” the brokerage said.

©2018 Bloomberg L.P.