Nilesh Shah of Kotak says easing tax burden may help attract foreign flows, but won't be enough

The double burden of securities transaction tax (STT) and capital gains tax has long been a sore point for investors. Nilesh Shah, MD of Kotak Mahindra AMC, says the finance minister’s recent remarks raise hopes of a better balance between the two.

Finance minister Nirmala Sitharaman acknowledged on 13 October the debate over long-term capital gains (LTCG) tax and STT, but did not say whether the government would consider changes in the upcoming Union budget.

While it is a major hurdle for global investors, taxation alone isn't driving outflows, Shah said. Edited excerpts:

The finance minister’s recent remarks have revived hopes of a review of LTCG tax. How would a change benefit investors and the broader economy?

STT was initially introduced in lieu of capital gains tax, but capital gains tax was later brought back and rates for both were increased. This creates a double burden for investors, who pay both STT and capital gains tax without getting credit for STT against their capital gains liability.

Foreign investors face an additional challenge. While Indian investors investing abroad may not face similar taxation, foreign investors investing in India do. Many cannot claim credit for the taxes paid here in their home countries. These tax frictions affect investment decisions.

The finance minister’s remarks are a step in the right direction and raise hopes of an equilibrium between STT and capital gains tax.

Could a tax change help bring foreign capital back to India?

It would remove one of the biggest hurdles for global investors, but taxation alone isn't driving outflows. The AI trade needs to reverse for money to flow into other markets, while rising US interest rates are pushing up return expectations. Geopolitical tensions in the Middle East are also raising energy costs and disrupting supply chains.

If these pressures ease, reducing the tax burden could certainly encourage global investment.

What worries you most about the markets right now – geopolitics, interest rates or earnings growth?

There isn't one dominant worry. Several factors have come together, from oil prices and supply disruptions to rising US interest rates, the AI trade and tax-related friction. The positive is that corporate earnings growth has remained solid despite the uncertainty.

I wouldn't call this a ‘Quit India’ movement by global investors. We have competed with global investors for anchor allocations in IPOs even as they have sold in the secondary market. They are also buying in the primary market and shifting portfolios across sectors and market caps. This is more about portfolio reallocation than an exit from India.

Has the market already priced in most of the bad news?

Much of what is known is already priced in at current market levels. Oil at $100-110 a barrel may be priced in, but $150 isn't. Similarly, markets may have factored in some increase in US interest rates, but not a much sharper rise.

If conditions worsen beyond current expectations, markets could fall further; if they improve, markets could recover.

Which sectors look attractive, and where should investors be cautious?

Avoid pockets where valuations are expensive and companies may struggle to meet earnings expectations. Remember, price is what you pay, and value is what you get.

We see opportunities in consumption, particularly discretionary spending and premiumization across automobiles, alcoholic beverages, travel and tourism. The implementation of the Eighth Pay Commission recommendations could put more money in the hands of over 2 crore government employees and pensioners, supporting these sectors.

Banking and financial services are another area we like. Deposit and credit growth are both above 15%, non-performing assets are at historic lows and valuations are below their historical averages. Foreign investor selling has weighed on prices, but a slowdown in selling could support a recovery. More importantly, there is a leadership transition happening in this space. Their strategies will have a positive rub off.

Are Indian investors becoming too conditioned to ‘buy the dip’ while foreign investors sell?

Global investors typically seek higher returns, while Indian investors are willing to settle for lower returns. This difference in expectations helps explain why foreign investors are selling while domestic investors continue buying.

Large- and mid-cap valuations are around 30% below September 2024 levels and below their historical averages. Small- and mid-cap earnings growth was around 20% in FY26, with momentum continuing into FY27. While some stocks remain expensive, valuations across much of the broader market are reasonable.

There is also greater scepticism towards India among foreign investors. Historically, bull markets often build on scepticism. Our view is that foreign selling reflects higher return expectations, while domestic investors are comfortable with more modest returns.

What would bring foreign portfolio investors back to India?

First, we need to remove investment frictions, including those arising from taxation. Second, India's earnings growth and valuations must look attractive relative to other markets. Third, we need to address global perceptions of India.

Our economy continues to grow, but international coverage sometimes focuses more on controversies than on the underlying numbers. We need to manage perceptions, remove friction and continue delivering growth.

What risks should investors keep in mind beyond market movements?

The one thing I can control is my reaction to market risk. During the covid times, I heard of a doctor who sold all his investments even though he did not need the money simply because he could not bear to see prices fall every day. His notional loss became a real one.

At the other end, a mutual fund distributor told me about an elderly woman who moved a large part of her debt-hybrid investments into equities and went on to multiply her money four to five times in the post-covid recovery.

Neither could have predicted covid. What mattered was how they responded to the correction. One turned a paper loss into a real loss; the other turned a market opportunity into substantial wealth.

You will never be able to predict everything the market does. Focus instead on managing your own greed and fear. When others are fearful, be willing to be greedy; when others are greedy, be cautious.