The much welcomed Budget proposal called Rajiv Gandhi Equity Savings Scheme (RGESS) has finally been notified. It has, however, evoked scepticism and a cold reception from market circles and the media.

The shrinking investor population has been highlighted as a long-term challenge for Indian markets, particularly with the growing influence of foreign investors.

Foreign investors of all types have been permitted, and these investors are known for their quick entry and exit, based on their own domestic reasons as well as for reasons that have origins in India.

An ordinary Indian investor’s financial investment is, therefore, susceptible to extraneous developments that he cannot track. This has made equity investments more complex and volatile for ordinary Indians, keeping them away from the markets. The only way to fight this imported volatility of the market is through enhanced domestic investor participation.

If the prices fall due to a fire sale by a foreign institutional investor (FII) facing a crisis, do we have matching resources to grab that opportunity and provide stability?

In this context, the RGESS window is a welcome attempt by the Government and the regulators to strengthen Indian domestic participation in equity markets.

Tax breaks

Many European countries have used tax breaks to grow and develop their markets when the markets were opened up for international investors. When these tax breaks were introduced in France, in a period of seven years, the proportion of domestic household investors went up from 7 per cent of total households to 17 per cent. This experiment was later successfully introduced in countries such as Germany, Belgium and Sweden.

In India, the total number of equity investors represented by Demat accounts is a mere 1. 3 per cent of total population, which is very low in comparison with around 17 per cent in the US and the UK, 10 per cent in China and 7 per cent in South Korea. In this context, although the tax break that RGESS proposes is very positive, it is not necessarily sufficient to attract significant investor attention.

Out of a total estimated 30 million tax payers with a taxable income of less than Rs 10 lakh, (as prescribed by regulators for RGESS eligibility), 16 million already have Demat accounts, limiting the universe to roughly 14 million. Even if the 4 million Demat accounts without holding are added, the eligible universe will be 18 million tax payers.

As 90 per cent of these tax payers come under the Rs 5 lakh-or-less income category (10 per cent tax slab), the available tax break for a full investment of Rs 50,000 will be to the tune of Rs 2,500. This is not a significant inducement to invest in a risky instrument such as equity.

Only an estimated 1.5 million tax payers, who come within the Rs 5-10 lakh taxable income category (20 per cent tax slab), who do not have Depository Participant (DP) accounts now will save Rs 5,000 when they invest Rs 50,000 in RGESS instruments.

For tax payers of the 10 per cent slab, the tax break is insignificant, and hence full investment up to Rs 50,000 should have been exempted from tax to make a significant impact. However, it makes sound policy sense to restrict this tax break to new investors as the idea is to provide economic inducement to savers who have not so far invested in equities.

This can provide stability to the capital market, through enhanced domestic participation. If the tax break is offered to all investors, incremental flows to market are unlikely to take place, while the loss of revenue will be significant.

The provision for exit from an invested stock is very positive, as the first-time investor will not be punished by a lock-in if something goes wrong with the company. Any investor will like to exit if there is a change in the investment prospects of a stock and can enter another stock within the eligible list to continue to avail of the tax break.

Also, the argument that the scheme is complex for a new investor doesn’t hold good as any new equity investor needs an intermediary to help him. This should be the responsibility of the community of stock brokers and DPs in the long-term interest of their own prosperity.

Need for hand-holding

While there are a lot of positives, RGESS may not take off due to another new initiative from the Government and the regulator.

Subsequent to the RGESS scheme, the market also received another announcement from the regulator about Basic Services Demat Account (BSDA) to retail investors who hold securities worth less than Rs 50,000.

All RGESS investors are supposed to get this benefit by which the Demat service is made free by the regulator. Although the intention behind this move is laudable, probably to popularise the RGESS, the private sector DPs are burdened by demands to provide free service to new investors. At a time when the cost of operation is growing by the day, it is unlikely that the DPs would extend this service free to anyone.

One visit by a DP to do in-person verification, which is mandatory for a DP account, will cost a minimum of Rs 200 in today’s world.

Therefore, it is difficult to assume that DPs and brokers will make any effort to market RGESS, which will require DPs to spend more time with a new investor to explain the complexities of the scheme as well as promote equity as an investment option.

It would be wrong to think that Indian investors are poor and hence need to be given free service. If income tax payers are not investing in equities, it is not because they are poor and cannot afford a Demat account, but because they are ignorant and risk-averse.

The intermediaries have to step in and hand-hold the potential investors in this context. For this, intermediation in financial markets needs to be acknowledged as a useful economic activity and has to be remunerative to make it work.

Hence, a well-meaning RGESS is cannibalised by another well-meaning initiative! These major path breaking announcements are, therefore, severally good and jointly bad for the market. We are back to square one.

Dead Capital Market

We, as a nation, take pride in having one of the best stock markets in the world in terms of number of contracts traded, volumes generated, algorithms used, etc.

There is intense competition in the exchange space, demonstrating vibrancy. But the reality is that we have a capital market that doesn’t help the Indian corporate sector to raise capital.

We have a capital market that doesn’t attract domestic investors as is evident in the falling MF folios and stagnant equity investor base. Our corporate sector is left only with banking channels for financing their investments.

A vibrant stock market with a dead capital market is a symptom of weakness, if not sickness, and not anything to take pride in.

The focus of our overall policy initiatives has to be to transform the capital market into a vibrant one for the corporate sector to raise capital to fund growth.

(The author is Managing Director, Geojit BNP Paribas. Views are personal. blfeedback@thehindu.co.in )

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