Tuesday, September 30, 2008

How double indexation increases return in FMP?

Finance minister Mr P.Chidambaram in one of the award function asked the recipient of the award "What is your wish list in this year's budget" and the recipient "he din want to pay more taxes" and the recipient is none other than India richest person Mr Mukesh Ambani. In return FM commented that "India is a country where a normal person as well as the richest person does not want to pay taxes".

If Mukesh Ambani himself is more conscious about paying taxes, aam aadmi like you and me should be trying to save taxes in a judicious manner. So lets see how we can reduce taxes on Fixed Maturity Plan by double indexation.

How is the profit taxed from debt mutual funds?

Debt mutual funds have a long term capital gain tax which is taxing the interest if the investment is held for more than a year. There are two methods of taxation.

1. 10% on the interest gained without indexation.

Taxable amount = Amount Returned - Amount Invested

2. 20% on the interest gained without indexation.

In the second gain, the taxable amount is calculated by

Taxable amount = Amount Returned – (Amount Invested * Inflation Index for Redemption financial Year/ Inflation Index for Investment financial Year)

Inflation index for every year is released by the govt.

Lets understand this concept with an example.

Assuming an FMP of 15 months returning 11% and Rs 10,000 is invested. Inflation index for 2006-2007 100 and inflation index for 2007-2008 is 105 and for 2008-2009 is 111. s Tax is calculated using indexation at the rate of 20%.

Scenario 1:

Amount invested in sep 2007.

Amount redeemed in Dec 2008 = Rs 11,000

Taxable Amount = 11000 - (10000 * (inflation index for 2008-2009 / inflation index for 2007-2008))

= 11000 - (10000 * 111/105)

= 11000 - 10571 = 430

Tax @ 20% = 20% of 430 = 86

Amount redeemed = 10914.

Scenario 2:

Amount invested in Mar 2007.

Amount redeemed in Dec 2008 = Rs 11,000

Taxable Amount = 11000 - (10000 * (inflation index for 2008-2009 / inflation index for 2006-2007))

= 11000 - (10000 * 111/100)

= 11000 - 11100 = -100

Net Loss = 100 and hence no tax.

Amount redeemed = 11000

So in this case we have totally avoided tax.


Hence while planning an FMP investment, we should plan it in such a way that it spans two financial years to get the advantage of double indexation.

Sensex may hit 10500 levels: Ramesh Damani


Ramesh Damani, a member of BSE, said that this is a rare moment and extraordinary time in the capital markets. He added that this crisis is a once in 100-year event. He feels Indian markets have not yet seen bear market bottom as yet and sees the market ranging between12,000 and 13,000 levels. He expects a huge slowdown in growth and sees the Sensex slipping to 10,500. 

Damani said, “Price corrections may be over in a few months but time corrections will not be regained.” He does not expect to see the Sensex at 20000 for a long time. 

Here is a verbatim transcript of the exclusive interview with Ramesh Damani on CNBC-TV18. Also watch the accompanying video.

Q: What do you expect to see now over the next few days given what has happened in the west?

A: This is like a one in fifty year event or once in a hundred year event almost. We are living through extraordinary times in capitalism since the Berlin Wall fell. Today, the market has been going down so fast that somewhere during the day we will see a point of maximum pessimism, but we probably aren’t at the final bottom in this bear market. Once the index has broken 12,500 it is not going to stop at 12,000. It is probably going to head significantly lower. In fact, the way to look at the market is that 12,500–13,000 is probably now the higher end of the range for our markets. So, we are in for a very tough time, and I will just quote you what Lenin used to say in 1920s that, “Capitalist will sell you that six foot of rope with which you will hang him.” Thus, that is pretty much what the Wall Street and all the central banks in the world have done and all the financial institutions have hung their own noose around themselves.

Q: How do you approach the panic this morning? Do you seek value right now, or do you say no we are going to get better prices the way things are going and that there is no hurry to just go out and buy stocks yet?

A: I am sure when everyone is selling one clearly wants to be the buyer. I am not sure whether one will make money over the next three weeks. If one goes through the cash section, there are companies trading at book value, cash value and asset values––a whole host of bargains are available not only in A group but also in B group. 

So one may cherry pick but he probably may not make money in the next three weeks. However, probably over the next 12 or 24-months, these investments will mature and do better. But having watched cash shares for the last two decades, I have never seen anything like this. It has just been a total disregard to volumes of 10,000 shares; stocks have gone down to around 10%. 

These are good legitimate companies, having good businesses with huge cash in the balance sheets, not leveraged. There is just an all round panic and rout in cash particularly. I think what we are now seeing is a rout coming into the A group. One should certainly step in and buy where one is convinced about it. 

Q: For a lot of people who watched bear markets in the past, the flow chart usually works with incessant price damage and then there is a period when the market does nothing. In that sense where do you think we are? Do you think this is going to be a much longer phase than many of us imagined in January?

A: I think so clearly. If one goes back and studies the history of bear markets, we are barely in the first five over of the game. Bear market requires time and price corrections; the price corrections will get over in the next few months but the time correction will not. There has been an entire generation of people on the Wall Street, for instance, when the Dow peaked at 1,000 in the 1960s, it did not see that new high on the Dow for a period of almost 18 years. People in Nikkei who saw the high in 1989 haven’t seen anywhere close to the highs. Hence, the great bull markets end in a flurry and then comes a new bull market. The greater the excesses that have been created in the past bull markets, the longer it takes for it to regain its highs. I think 20,000 is going to probably stand for a long time.

Q: Is there still a global situation as you read it, or as you indicated earlier do you think now the domestic infrastructure in terms of growth expectations, etc. will start coming apart a bit?

A: The point I am trying to make is we have moved from an economy that was globally very leveraged, where capital was easy, there was an idea, a project and particularly in emerging markets such as India, money was thrown at promoters. One had a case where one bet the balance sheets and his stock price went up 10-times. It was in a capital expansionary phase and people forgot to respect the capital. People forgot to respect return on capital assets. Hence, the market now would go from a global leveraged situation to a global de-leveraged situation, and the first wicket that will be knocked off to continue analogy is growth because capital is not available for expansion. They will be put on hold because as growth subsides all the subsidiary functions will be put on hold. So, we will see a huge slowdown in growth. The predictions of 7-8% Gross Domestic Product (GDP) growth probably will have to go slightly down even in cases like India. Once that growth goes down the Price-Earnings (P/E) will be knocked off which is probably happening in India at present. 

Thus, we are going to get through an environment, where if one gets a company which grows at 15–20% and is available at a P/E of 7–8 times, it will probably be a great investment to lock in. The arrears that company could grow at 35–40% are clearly behind us for the immediate future.

Q: Past bear markets have generally taken out 50% in some cases more. Do you think from 21,000 we could get whittle down to 10,000–10,500 Sensex? Is that conceivable according to you on current reckoning?

A: I think it is entirely conceivable. Markets can be overvalued for long periods of time; 10,000 might be an undervaluation watermark for the market. We could remain undervalued for a long period of time, especially, given the hit that people who have invested in equity in 2006-2007-2008 have taken. I am very certain that bear markets will end in a revulsion; they do not end in denial. A few weeks ago, most global players, a lot of local players were in a state of denial, it was an interruption, it was a correction that the bull market would continue on. The market has now decisively proved that we are in a bear market and bear markets take time. The one thing that bear markets require is not only price but the dimension of time. So it will take time. It is definitely conceivable to me that markets could remain undervalued now for a long period of time.  

Q: Adrian Mowat from JP Morgan made the point that any support will come in from domestic hands. Do you see that likely in our market because if the rout spreads to the A Group as you said, what will happen with the Domestic Institutional Investors (DIIs), mutual funds, etc.?

A: They have been great supports to the Indian market. They have been consistently buying in a very disciplined and logical manner. However, sometimes water just goes over the dam and one cannot hold it. The water has just rushed over it. There is very little one can do. It will find its own level. 

India needs to distinguish between what happens in the markets and what happens in the economy. I think as an economy we are underleveraged, we will plod along. We have our own strengths that we will play to. I think markets are going to take a shellacking because there could be periods when the economy continues to do fine, the stock markets do not do well. The great mistake people make is that they think those two are related but those are not related. There could be periods of time when the economy will grow at 6.5–7% and the market will not do anything. For example, China, which has been growing 8–10% for the last 10 years and yet the stock market has collapsed 60–70%. Thus, it is basically double from where it started. 

So there is no holy grail that says if GDP (gross domestic product) growth is 7% the markets will follow suit.

Q: You have been a believer in higher crude prices for a while now. Do you think there will be a period where everything in terms of asset classes underperforms and something like gold are the ones that stand tallest? 

A: There is a case for buying gold. However, one doesn’t want to put large percentage of portfolio in it because there is basically a problem storing it. It doesn’t pay the interest to dividends and is basically a very non-productive asset. But as an insurance cover, gold serves two purposes. In case of inflation, it acts as a store of value and then against insurance. The kind of damage one has seen in paper assets means that we will move to harder assets which they know the value of and a common consensus historically has been gold. 

Gold is now trading at almost a 30-year high. Having tested that high it retraced back 20% and now it has gone back to that high. If gold can stay above USD 950–1,000 per ounce, we could see a very sharp upmove in gold. So yes, there is a case for putting maybe a few percentage of one’s portfolio into gold which is basically a non-productive investment. However, in uncertain times like this, gold will often be viewed as a safe haven. So, it does make sense to be a part of one’s portfolio; not maybe a major chunk but maybe as an insurance. 

Marc Faber and a lot of other analysts on the Wall Street have pointed out the ratio between the Dow and the gold, which in 1979, when gold was USD 1,000 per ounce, was 1:1. They are saying that if we move again, the ratio that is now is maybe 10:1, may be 5:5. Subsequently, there could be a sharp fall in equities and a rise in gold. These are theories, I am not saying this can happen but clearly the market has fallen out of love with paper assets. In that case they will move towards gold. 

Q: You have been bearish for sometime now and we are nine-months into this bear market. What’s your sense of how long we have got to crutch along in this bear market?

A: My sense is that it would take time––it might take two to three years before we actually get out of this bear market because bull markets are driven on liquidity. All the analysts and all the papers you read, the inter-bank market is basically frozen in America. Banks are lending to each other.  

Everything works on trust so when we go to restaurants, for instance, and we order a meal, the owner assumes that we will pay him at the end of the meal. It operates on trust. We clearly can’t have a contract for that.

Similarly, the inter-bank market also works on trust, and now, because of these failures, defaults and bankruptcy, the trust is completely vanished. So unless the US goes back and reintroduces the liquidity of the market, introducing a bailout package, it is going to be a long time when people will fund any projects. So people in mature markets, having got such a shellacking at home, will now come and invest in emerging markets which is even more riskier. Conventionally speaking, it seems illogical to me and if capital is not available there will be a problem in growth.
http://www.moneycontrol.com/india/news/market-outlook/sensex-may-hit-10500-levels-ramesh-damani/358913

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