The Indian government has taken steps to suppress the stock market.

On the 23rd local time, the Indian government submitted the central budget. The budget proposed an increase in capital gains tax and derivatives transaction tax on equity investments. India's Finance Minister Nirmala Sitharaman announced:

Financial assets held for less than 12 months are subject to 20% capital gains tax (short-term capital gains tax STCG), compared to 15% previously.

A 12.5% capital gains tax (LTCG) is levied on financial assets held for more than one year, compared to 10% previously.

Since October 1, the transaction tax on stock options has been raised to 0.1%, and the futures transaction tax has been raised to 0.02%. Previously, it was 0.0625% and 0.0125%, respectively.

The Indian government is taking heavy action this time, also to cool down the speculative fanaticism of Indian retail investors.

Indian government raises taxes to crack down on speculative fanaticism

Since 2020, Indian stocks have reached several record highs, continuing the strong gains that began in the previous calendar year. Currently, the market value of Indian stocks is over 5 trillion US dollars.

Analysts believe this is mainly due to the strong participation of Indian retail investors. The number of retail investor accounts in India has more than tripled since 2020 to about 0.16 billion. Especially among young people, it is becoming popular to buy stocks and options like crazy. In January of this year alone, the nominal trading volume of Indian stock derivatives reached an astonishing 6 trillion US dollars, surpassing the size of India's economy.

According to Bank of America data, the average daily nominal trading volume of India's Nifty 50 index options this year is about 1.64 trillion US dollars, which has already surpassed the S&P 500 index of 1.44 trillion US dollars.

Seeing that India's stock derivatives trading volume soared to such a high level, the Indian government feared that households would use all of their savings for speculation, and continued to warn against increasing speculation in the market before hoping that tax increases would cool down speculation frenzy.

Despite this, the Indian stock market remained calm on the news of the tax crackdown. India's NSE Nifty 50 index fell 1.8% when the news first came out, and almost recovered all of its decline thereafter.

Vikas Khemani, founder of Carnelian Asset Management, said that tax changes are not expected to have a significant impact on market sentiment and are still confident about investing in India.

What is certain is that in the weeks before the budget was announced, a series of warnings issued by the Indian government to curb retail speculation have weakened the momentum of stock derivatives trading in India. According to data compiled by foreign media, the nominal trading volume of Indian stock derivatives dropped to 3.3 trillion US dollars this Monday, down more than 40% from the peak in February.

How will the increase in capital gains tax affect the Indian market?

Analysts generally believe that tax increases may have a negative impact in the early stages, but the negative impact will soon subside. In the long run, these measures may bring long-term benefits to the Indian capital market, as these measures will promote a more sustainable and balanced investment pattern.

Shlok Srivastav, co-founder of Decision-making, said that in all fairness, the market and business ecosystem want more reasonable tax rates on long-term and short-term capital gains.

Given that the derivatives market is once again showing signs of overheating, it makes sense to drastically adjust the short-term capital gains tax from 15% to 20%. India's market regulator recently stated that the growth in derivatives trading volume has risen from a micro level problem to a macro level problem, which largely suggests that the Indian government is actively addressing excessive speculation in the derivatives market.

At the same time, we appreciate the revision of the Indian government to adjust the long-term capital gains tax. For serious long-term investors, raising the capital gains tax from 10% to 12.5% will have little impact on larger returns. Moreover, it will encourage investors to enter the Indian market with reasonable long-term expectations and encourage them to become actual stakeholders in the country's economic growth story. Of course, a long-term capital gains tax increase will dampen market sentiment for a period of time, but we also know later that capital market participants will accept this adjustment and move forward.

Kotak Securities Chairman and CEO Shripal Shah also said that the federal budget sets out a clear vision for India's economic future, putting growth and fiscal responsibility first. This tax increase is all aimed at mitigating current excessive stock market speculation and allowing the stock market to grow at a sustainable rate.

We anticipate that there will be a small adjustment period as the market adapts to these new tax rates, but this will ultimately help form a sustainable investment environment and enable the capital market to develop in a balanced and orderly manner.

Shripal Shah also stated that India's 2024 budget aims to balance investor interests with long-term market stability. The rationalization of the capital gains tax system is expected to bring investors a simpler and easier to operate investment environment, thereby promoting the participation of more investors.

Aman Soni, head of Prudent Equity, believes that the tax rate adjustment was a direct blow; however, it did not change investors' interest in the Indian stock market. As more retail investors participate, the Indian capital market will continue to expand, and investors should focus on identifying stocks that suit their understanding and risk appetite, and continue to invest.

Even after the capital gains tax is raised, stocks will still be the preferred asset class. From all aspects, stocks will continue to provide good returns. Considering the cancellation of indexed earnings in real estate transactions, this indicates that stocks will generally become the preferred asset class for investors.