Cryptonite?
Crypto Tax ripple effect, Riskier investment bets, HDFC Ltd X HDFC Bank, RBI's strict new approach 💸 💪 🌱
April brings in the new financial year which means your taxes just said, “New Year, New Me”. And while no one gets too excited about new taxes, some people are particularly unhappy about it this year. Also, here’s a riddle for you. What has two Hs, two Ds, two Fs and two Cs? The HDFC merger, of course. All this and more in today’s edition of TGI Fi Day.
Crypto Collapse?
New year, new tax
April marks the new year in the lunar calendar system with Indians celebrating a number of regional festivals from Ugadi to Gudipadwa to Cheti Chand. But there’s one new year which not many people are celebrating - the financial new year. It's a time when you usually find your company’s accounts team scrambling to meet filing deadlines. But it's also a time when the new taxes announced by the government during the Budget session of Parliament come into effect. And there’s one group of people who are particularly unhappy about it.
Unhappy investors
Crypto investors and the crypto industry. You must be aware by now of the taxes that the government decided to impose on ‘virtual digital assets’ (VDA). Here’s a quick refresher. A flat 30% tax on gains from VDAs and no setoff allowed on any losses. Both these have become effective from April 1. Crypto exchanges are already witnessing their impact. Trading volumes hit a peak on March 31, and then crashed by up to 70%. Many traders who felt a 30% tax would only add to their losses decided to liquidate their crypto holdings.
Sluggish growth
The top 5-6 Indian crypto platforms had recorded phenomenal growth last year, clocking nearly $100 billion in trading volumes. The industry fears this year will see sluggish growth based on the market behaviour within the first week of the new tax code kicking in. The profile of crypto investors is also changing from young investors from tier 2 and 3 cities who can’t afford the tax to high net worth individuals (HNIs). And all this even before the 1% tax deducted at source (TDS) on all VDA transactions is implemented from July 1.
Stifling taxes
The crypto industry had lobbied hard for allowing losses to be set off against gains on VDAs. The government’s move to disallow setoffs is seen as quite harsh and discouraging to investors. Further, a 30% tax treats crypto investing on par with gambling. The industry also lobbied for reducing the TDS to 0.01%, given the aim of the government was simply to track transactions. The current tax regime is seen as stifling innovation in a fast-growing sector while redirecting funds abroad.
From Debt to Debt
Winds of change
We’ve spoken in the past about how negative real returns on instruments like fixed deposits drove a lot of Indians to become first-time investors in the capital market. Just to recap, to counter the financial impact of the pandemic, central banks around the world reduced their policy rates to make money cheaply available to firms during difficult times. But the flip side was that interest rates on fixed deposits also fell. And as inflation shot up, they began giving negative returns. But the winds of change are blowing once again.
Unattractive debt
From a financial perspective, fixed deposits are an ultra-conservative investment option. For investors with a slightly larger risk appetite, there are debt mutual funds. They invest in corporate and government debt which offer higher returns than FDs but have a lower risk profile than stocks. But the returns here too have turned unattractive over the past year. Certain debt mutual funds are yielding returns as low as 3.3%. The Reserve Bank of India expects inflation at 5.3% for the financial year 2021-22. So, what are investors doing?
Riskier conservatives
Investors are taking riskier bets. Industry data showed that the number of folios in debt mutual funds fell to 7.45 million from 8.25 million a year ago. The money is flowing into instruments like peer-to-peer lending that offers over 12% returns and balanced advantage mutual funds that can switch between debt and equity investments. This trend might continue for another reason - interest rate risk.
Interesting risk
Interest rate risk is the potential loss on your investments resulting from a change in interest rates. For example, you’ve invested in a 10-year bond yielding 5% interest. Then, the RBI decides inflation is too high and hikes its policy rate, pushing up bond yields, which in turn reduce prices. New bond issues are now yielding up to 7% and you’re stuck with 5% (unless you sell your bonds at a loss). And this is what debt investors are concerned about as the RBI’s Monetary Policy Committee hiked its retail inflation estimate to 5.7% for this year.
HDFC HDFC
Avengers, Merge!
Recently HDFC Ltd and HDFC Bank announced a merger, which if gone through, will be a force to be reckoned with - the 3rd largest entity in India (HDFC Ltd will get dissolved as an entity after the merger). The merger has helped stabilise the share prices of HDFC bank after its recent underperformance. This underperformance had two main reasons. One, due to RBI disciplinary actions to correct the outages in Internet banking. And two, the geopolitical tensions because of the Russia-Ukraine war prompted foreign institutional investors to shift to safer markets, which adversely affected banks, including HDFC Bank.
Stars aligned
The merger announcement spiked the share prices of both HDFC Ltd and HDFC Bank stocks by around 15%. This is because of the potential synergies that this merger would bring. For instance, the merger would allow them to cross-sell products to a larger customer base. The banking model would help HDFC Ltd to flourish further in the booming housing loans sector. This is because the debt market in India isn’t adept at handling the demand for housing loans. The merged entity’s banking structure would help in terms of financing these loans through deposits, and a generally lower cost of borrowing.
Happy Marriage (with a few bumps)
Seeing that the markets have reacted positively to the merger, it seems like the merger if given the green light will be a good marriage. But there are still a few things that might deter the short-term profitability of the merged entity. HDFC Ltd has 80% loans in its books - which give low yields; this might affect the profitability of the merged entity. Also since the merged entity will have to follow the banking guidelines, SLR and CRR need to be maintained as well. This basically means that a portion of their deposits will have to be kept aside and not given out as loans; this could impact profit margins in the short-run as well.
Strictly yours
A tough nut to crack
Remember that one teacher in school that everyone used to be scared of? One that used to make even the furthest backbenchers turn up with their homework? The RBI in recent times has donned this hat of being the regulator all institutions under its purview are panicky about. Recent examples of this strict approach can be seen with the RBI’s IT scrutiny of and subsequent sanctions on Paytm Payments Bank, Mastercard, and HDFC.
Coming of digital age
The increase in scrutiny of banks is proportional to the increase in digitisation of banking. After the price people had to pay for RBI’s lapse in oversight of Yes Banks and Punjab National Bank, it turned on high-alert mode. Its penalties are harsher and its checks more thorough. This is making banks delay the rollout of new digital features, lest they be violating the RBI framework. Although this is great from a consumer protection standpoint, when does this regulation become too much?
Less talk, more Hawk
Under the new RBI framework, each and every lapse is graded at the same level of severity. This means the margin of error is non-existent. What this does in some cases is deter them from developing more robust systems and instead make them focus on sieving out any lapses. For instance, internal systems testing is mandated to be done every 3 months, as opposed to every 12 months. This hampers the quality of testing in the interest of checking the compliance boxes of the RBI.
Regulation in a rapidly digitalising banking world is exactly what people need in a world where digital banking is met with a lot of apprehensions with respect to security. But, the RBI needs to be wary that these institutions are not stretched beyond their capacity.