PREFACE

Money
Simplified
Investment Guide
2005
Copyright:
Quantum Information
Services Limited
Websites:
www.personalfn.com
www.equitymaster.com
Contact Information:
Quantum Information
Services Limited,
404, Damji Shamji
Vidyavihar (W),
Mumbai - 86 India
Email:
info@personalfn.com
Contact No.:
022 - 5599 1234
Content:
Anand Oke
Irfan H Rupani
Vicky Mehta
Rahul Goel
Supported by:

CONTENTS
Your most likely reaction to this issue of Money
Simplified is going to be, "Oh no! Not another Investment Guide for 2005!" We understand you
completely!
Over the last two months, several newspapers and
magazines have come out with specials, supplements or call it what they like, on what year 2005 is
going to be like from an investment perspective.
You probably read some of this. We did too. Some
of the content we read was good from a 'reporting'
perspective. Most of it was poor in quality.
This inspired us, a team of experienced and qualified personal finance and equity analysts, to put
together a guide which will assist you, our readers, in planning your investments from a one year
(and longer) perspective. Throughout this guide
our aim, as always, has been to help you select the
investment opportunity that best suits your risk
profile and return expectations. There are no 'tips'
in this guide. Our loyal readers, now exceeding
52,000, know there never will be.

Asset Allocation Guide for 2005

Defining the foundations by Ajit Dayal

Beyond the vicious circle... - by Equitymaster

10

Equity Funds: The road ahead...

13

Risk-averse investors: Tough times ahead!

15

Interest rates in 2005 - by Rajiv Anand -

17

Insurance: Innovation will be the key

19

Property: Where to invest - by Sorabh Jain

22

Gold: All that glitters need not be a great investment

26

Taxation: Will these provisions change in 2005?

28

This issue of Money Simplified will serve as your

one-stop reference point when planning your investment strategy for 2005. Our scope of coverage
extends from stocks to property, from fixed income
instruments to gold. There is even a note on what
to expect in terms of changes in taxation laws.
We request you to share with us your views on
this issue of the Money Simplified and our website
www.personalfn.com. This will help us in making
our offerings more meaningful for you.
Wish you a very happy and prosperous 2005!
Team Personalfn
15th January 2005

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Copyright: Quantum Information Services Limited.

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Asset Allocation
Asset Allocation Guide for 2005
The New Year brings with it changes,
some pleasant, some not so pleasant. As an investor, are you well
placed to benefit from the positives
and to counter the negatives of 2005?
In this note we outline an asset allocation strategy for investors in 2005.

certain level of market capitalisation,

say Rs 10 bn (Rs 1,000 crores). Mid
cap funds have above-average risk as
mid cap stocks are under-researched
and have lower liquidity; but they
also have potential to deliver aboveaverage growth.

Notice we don't call it 'The Asset

Allocation Strategy'. We understand
that you can't have a "one-size-fitsall" strategy. Given that individual
needs are different, necessary adjustments will have to be made to your
portfolio to reflect specific needs.

You can also consider investing a

portion of your assets in a sector fund
depending on whether you have an
informed view on the sector and understand the above-average risks associated with them.

If you are between 25-40 years of age

Given your age, you are in a position
to take above-average risk to achieve
your financial goals. You can afford
to have 70% of your investments in
equities by investing in assets like
diversified equity funds, sector
funds, tax-saving funds, balanced
funds and stocks. The balance
should be in bonds, small saving
schemes, debt funds and cash.
You must first look at investing in a
steady, well-managed, diversified
equity fund that invests predominantly in large sized companies (typically from the Sensex and Nifty). Such
companies are well placed to drive
your portfolio over the next 10 years.

For those planning their taxes, ensure

you invest in tax-saving funds (maximum permissible limit of Rs 10,000. )
Investors with a moderate risk profile
can consider investing in balanced
funds and give the mid cap and sector funds a miss instead.
On the debt side, investors must consider investing a portion of their assets in small savings scheme. Given
the wave of rationalisation these
schemes are likely to witness, you are
unlikely to see such high-yielding investments along with attractive tax
benefits in future. First consider the
Public Provident Fund (PPF) given
that its rate is revised every year allowing you to benefit from a rising
interest rate scenario. Then take a
look at National Savings Certificate
(NSC) wherein you can lock the rate
at the current level (8% p.a. compounded) - a good return in these
times and a tax benefit to boot. Also
look at the 8% GOI Bond to exhaust

Another equity fund that you must

consider owning is of the mid-sized
variety. Mid-cap funds invest largely
in companies drawn from S&P CNX
500, BSE Midcap or some benchmark
of this nature for companies with a
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3

Asset Allocation
the Rs 3,000 tax benefit under Section
80 L, something most investors ignore.
Consider investing in floating rate
funds to insulate your portfolio from
debt market volatility. Debt funds are
an investment proposition you must
consider with a minimum 18-month
horizon. For liquidity purposes, you
can opt for 5% of your assets in cash/
liquid funds and savings account.
Many individuals tend to be partial to
investing in property. For an individual planning to get married this is a
necessity. Investing in property
makes eminent
sense especially
given that home
loan rates are a lot
lower than what
they used to be till
even two years
ago. Add to that
the tax benefits
and you have
more than one
reason to buy
property.

tirement kitty. (In an earlier issue of

Money Simplified - The definitive
guide to Tax Planning we have outlined a detailed insurance strategy.)
If you are between 40-55 years of age
You are in a position to take some risk.
This means that you can invest in equity-oriented products, but not as
much as you could have when you
were younger. You must look at building a 60:40 (equity:debt) portfolio.
You must consider owning a steady,
large cap, diversi- fied equity fund
as also a wellmanaged mid cap
fund. Given your
relatively low risk
appetite ignore
the equity funds
of the sectoral
and opportunities
type.

You must

consider tax-saving

funds while chalking

out a tax-planning
strategy.

For your insurance needs, consider a

term plan first, given the lower premiums. You can take a ULIP (unit-linked
plan); but considering that you already
have a lot of equity in your portfolio,
take a ULIP with lower equity component (not more than 20%). Also compare the costs of investing in ULIPs
across companies. For parents, it is
important to take a look at plans of insurance companies and/or mutual
funds to plan for the child's future.
Consider pension to save for your re-

You must consider tax-saving

funds
while
chalking out a tax-planning strategy.
Balanced funds will fit nicely in your
portfolio. The debt component can
serve to mitigate the risk of equities
and provide stability. In fact as you
approach 55 years of age, balanced
funds and monthly income plans
(MIPs) should be primary windows to
equities. You should have phased out
your 100% equity funds.
Floating rate funds and long-term
debt funds can form a chunk of your
debt portfolio. If you aren't sufficiently invested in equities (to the ex-

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Asset Allocation
tent of 60% of your portfolio), you can
also consider MIPs. Our advice to investors interested in small savings
scheme is the same as the one we had
for the higher risk investor. First look
at PPF to benefit from a rise in interest
rates and then at NSC.
Our advice to investors on property
is the same across age groups, which
means that if you can afford to invest
in (another) property go for it. You
have 2 factors working for you - lower
home loan rates and tax benefits, and
you should make the most of them.
In terms of retirement planning, it is
important for you to get a pension
plan. If you don't have a term plan already, consider taking a term plan. At
this age other insurance plans (endowment, ULIP) will be very expensive.
If you are over 55 years of age
At this advanced age, it would be prudent to shun risk and strive to achieve
your financial goals by taking on minimal risk. If at all, you can allow yourself the luxury of a small equity exposure (10-15%) to supplement the existing investments in your portfolio.
Since regular income post-retirement
is your most pressing need, your investments must reflect this important
trait. The Senior Citizens Savings
Scheme (SCS) is a must-have given
that it is targeted at retirees and gives
a rate of return (9% per annum) that is
far superior to comparable avenues.
The Post Office Monthly Income
Scheme (POMIS) should be the second most important investment in
5

Stock Market
your portfolio, although at 8% p.a.,
the return is lower than the SCS.
Go for fixed deposits with the monthly
payout option. You also have variable
fixed deposits wherein the rate of interest is revised at regular intervals;
this should enable you to benefit from
a rising interest rate scenario.
Take the 8% GOI Bond (annual payout). This investment also has an exclusive tax benefit under Section 80L.
If your risk appetite permits you, consider investing a small portion of your
surplus in low-risk MIPs (please note
MIPs do not assure a return). If you
are selecting the dividend payout option, choose the quarterly or halfyearly payout option as market volatility could lead to skipped dividends
as we have witnessed in the past.
An annuity in your portfolio is an absolute must. Unfortunately you don't
have a lot of options given that the
pension/annuity segment is yet evolving. The good news is that pension
reforms are 'round the corner' so to
speak and the annuities segment
could throw up a range of interesting
options for individuals.
We have tried to chalk out a plausible
asset allocation strategy. We understand that while this could be just
what the doctor ordered for a group
of individuals, it could be off the mark
for another group. The important
thing is to start thinking on these lines
and come up with a strategy that
works best for you, within the broad
risk-return parameters that we have
tried to define in this note.

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Defining the foundations

We made 3 macro predictions for the
year 2004:
1. There would be another buying
opportunity (when the Index was
6,000 plus in Jan 2004 on
www.equitymaster.com);
2. The NDA government would win
but not with the huge majority that
everyone expected and hence the
markets would fall (February, 2004 at
an Investor Education meet organized by www.personalfn.com); and
3. the markets would end the year
2004 lower than the level at which
they began (a BSE-30 Index lower
than 5,950)
Depending on what you expect of
your local astrologer, you would either say that we are geniuses for getting the overall trends right or you
could say that we missed the mark
completely because the NDA government did not win, the BSE-30 Index
actually gained +18% for the year (on
a total return basis), and - while there
was a buying opportunity - investors
had "only" 3 months to jump back in
the markets. If you are unhappy
about our predictions for 2004, stop
reading further for what follows is not
for those who judge us on a mark-tominute basis.
Recapping 2004
Swept by the "India Shining" re-election campaign of the 12-party National Democratic Alliance (NDA)
government and a wall of money willing to buy the "back-office to the
world" story, the BSE-30 Index soared

above the 6,000 levels in January,

2004. However, the loss of the NDA
in the general elections and the creation of the United Progressive Alliance (a 15-party group led by the
Congress which also includes the
Communists) shocked investors.
On May 17, 2004 the BSE-30 Index saw
its largest one-day point decline when
foreign investors (the largest net buyers of Indian equities over the past
three years) began to unwind their
positions. The involvement of the
Communist Party with their traditional
agenda of reviewing the "reform process" in a new government was perceived to be bad news. However, the
sell-off on "Black Monday" was, in
our view, excessive. The subsequent
run-up in the market and the consecutive new highs established by the
BSE-30 Index in December 2004 vindicates our stand that this Congressled government has the credentials
and desire to keep reforms going.
The foundation is still weak
Although rising markets make us
happy (and clients, too), we are a little
perturbed about traces of "irrational
exuberance". Not that we are selling
aggressively into this rally. In January 2004 when the BSE-30 Index had
crossed the 6,000 levels we raised our
cash levels from 2% to nearly 35%,
and maintained this unusually high
cash level for four long months till
May 17th. As of December 2004 our
cash level is less than 2% and we remain invested - for now.

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Stock Market
While we continue to remain bullish
on India on a three to five year view,
our 14-years of experience prompts us
to always look for signs of excess. Our
caution is a result of institutional imbalances typical of economies that
face new opportunities and risks and
don't quite have the institutional bases
to sustain the move to the next step:
1. Frothiness that is emerging in retail lending and consumption as
banks fight to grow their low retail
lending books (was 3% of total bank
loans in FY2003 and is estimated to
grow to 7% by FY2006) - a credit bureau has only recently been established and bad loans are a risk,
2. A misalignment of risk and return
in equity markets where everyone
looks to justify current share prices
based on March 2008 earnings potential - not advisable in a country where
the monsoon, politics, and social issues carry significant event risk,
3. Structural imbalances in ownership and money flows - foreign funds
have been the buyers of Indian equities for the past 20 months except May
2004 when foreign funds sold US$ 750
million and domestic mutual funds
bought US$ 250 million of equities;
on a cumulative basis, foreign funds
have bought US$ 16 billion of equities since April 2003 while domestic
mutual funds have sold US$ 2 billion.
The excessive reliance and obsession
with foreign flows is a danger as global events (such as an interest rate
increase in USA) could cause this
huge sucking sound as money gets
pulled out of India back to their home
countries. The lack of buying by local
retail investors indicates the torture
7

Stock Market
and pain that they have been through
since 1991 when the first of many scandals decimated their life savings - and
trust.
4. The "India Shining" ad campaign
is replaced by an "India is Global"
attitude where everything from India
is going to conquer the world of business - a recent advertisement shows a
young Indian businessmen buying the
East India Company, the multinational
that resulted in the British ruling India
for over 200 years. The truth is that
while some Indian companies will succeed, many more will fail as the sheer
cost of going "global" is beyond the
balance sheet capabilities and management bandwidths of most companies.
5. "This time it's different" type of
power points and research reports are
appearing - just as they did in 1994/
1995 - months before an inflated Indian economy came to a hard landing
that led to a 4-year bear market (this
was also a result of rising interest rates
in USA). Although we do not believe
the economy will head into a 1995 scenario, there could be a lowering of
growth and growth expectations.
6. The flood of IPOs from all kinds of
companies is a perpetual risk to a bull
run - when stock markets run up,
founder families (unwittingly known
as "promoters" in India) are out there
touting their shares and their dreams
to unsuspecting, or simply greedy, investors. This is a global phenomena
and there is no remedy for it - barring
the natural course of events and an
eventual market correction.
The difference between 1995 and
2005?

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Well, ten years is the obvious answer.

But there have been significant
changes in India and in the Indian
stock markets over the past ten years
that does, well, make us confess that
this time it's somewhat different.
There is little doubt that the Indian
economy is a lot more efficient today
than it was in 1995. Capital allocation
between the government and the private sector is more "market-driven"
with most interest rates set by free
market forces and money increasingly
free to move between various asset
classes within
the Indian borders. Companies
are
certainly
more efficient today than they
have ever been.
Indian managements have used
text-book methods to cut the excessive fat in
their working
capital and wringing more revenues
from their asset bases. Changes in the
global environment, (the WTO, the
birth of the internet, lower telecom
rates, and more acceptance of the
"Made in India" label for a range of
products and services) justifiably allow Indian companies to earn the accolade: You have come a long way,
baby.

ods get exposed in recessions.

Banking regulations, while fabulous
compared to China, are still far from
perfect with many of the smaller cooperative banks pretty much a writeoff. And the aggressive bank lending,
more recently in retail loans, by some
of the larger banks has caused the
Reserve Bank of India to step in a few
times with moral suasion and open
action.
On the regulatory front, the Securities and Exchange Board of India
(SEBI) has taken
many steps to
protect investors.
While the number
of cases it has
filed against market intermediaries
has increased, it
has recently lost
some very highprofile appeals
that question the
quality of its investigation. Regulators need to be
feared and respected by the entities
they regulate. Keeping in mind that
SEBI is barely ten years "old", the
overall performance has been reasonable but now, as we enter a new era of
even greater market activity, the dialogue between SEBI and those that it
regulates needs to increase. The key
objective of the regulator and the
regulated must be to build systems
and structures that encourage domestic participation in the capital markets
and provide safeguards and mechanisms to protect the retail investors.

Regulators

need to be feared
and respected by
the entities they
regulate.

But there are still negatives swept

away under the carpet when stock
markets are rising. These will emerge
to haunt us when markets fall off a
cliff - just as bad accounting meth-

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Stock Market
On a macro front, the new government
has had to adjust to the internal dynamics of a coalition in its infancy and
has had some awkward moments when
dealing with foreign ownership issues.
Infrastructure, much talked about
since 1991, may finally get off the
ground this time around but is already
choking the growth of established cities like Bombay and the newer generation cities like Bangalore.
All this is typical of an economy beginning to flex its muscles and achieve
its true potential but still does not
have all the frameworks in place. The
frameworks will come, we are confident of that. But it could take another
five years or more.
Meanwhile, based on fundamentals,
the BSE-30 Index could touch 7,800 a further upside of 25% from here - by

Stock Market
February 2006. Alas, the way the market is running, it could get there earlier. Ever-watchful of long-term valuations, our cash positions are likely to
be more than 1% if share prices runup ahead of fundamentals.
Rapidly rising markets make our job
more interesting as we face the dual
challenges of selecting stocks that are
undervalued in an optimistic environment while ensuring that client expectations are tempered. But we love such
challenges and have lived through
many market cycles to feel comfortable
in all environments: bear markets, bull
markets, or flat markets do not faze us
- managing your money is our business.
By Ajit Dayal. Ajit is the CEO & CIO of
Quatum Advisors. He can be reached at
ajit@qasl.com

Beyond the vicious circle

Had expectations at the start of the
calendar year 2004 been right, the
BSE Sensex should have been anywhere in the range of 7,500 to 8,000
by now! Alas, it did not turn out to
be that way. If calendar year 2003 was
a one-way ride for the stock markets
(up 73%), the year 2004 was a volatile one. This was despite the benchmark indices gaining 15% point-topoint. Is this a sign of things to
come? In such volatile markets, which
sectors should investors invest in
and what should be the time horizon?
Instead of dwelling too much on what
influenced the stock markets in 2004,
we highlight some of the key aspects
that are broader in nature, which we
believe were not properly acknowledged by the markets. To begin with,
despite election jitters in the first
quarter, the fact that India managed
to absorb the transition in leadership
at the Centre proves the strength of
our democratic setup. This is of sigBSE sectoral indices - 'IT' is back!

(Rs)
140

Bankex

130

Cap Goods
BSE 200

120
Sensex

110
100

Infotech

Healthcare
PSU

Consumers
FMCG

90

nificant importance because political

stability is paramount in the topdown approach to investing. Secondly, despite seeing one of its biggest falls on May 17th, the market
bounced back and in this case, fundamentals ruled. Thirdly, as Mahesh
Vyas of CMIE puts it, "The institu9

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tional framework today in India is so

good that in spite of such a severe
stock market crash, there was no payment crisis."
Coming to the stock market performance, the BSE Sensex gained 15% in
calendar year 2004. But as always,
there were winners and losers in terms
of returns. The under-performance of
the BSE FMCG index for the second
year in succession was not a surprise
to many, especially given the inability of the players to expand the market. On the other hand, one of the
major underperformers in the calendar year 2003 i.e. the BSE IT index
bounced back in 2004. Also, expectations of the government fast-tracking
the consolidation process and the
second half recovery in non-food
credit resulted in the BSE Bankex outperforming other sectors.
Another flavor of the year was the
mid-cap stock segment. Though there
is no standardisation in equity markets with regard to what can be termed
as 'mid-caps', even DSQ Software
found buyers supposedly because it
is a 'mid-cap' company with 'promising' growth potential! Factors like
poor track record, lack of information
and low liquidity are some of the risks
that investors need to bear in mind
before investing in mid-caps.
Our view for 2005 and beyond...

In the past, share prices of companies have usually traced their fundamentals i.e. earnings growth. And the
future is not going to be different. We
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10

Stock Market

Stock Market

have substantiated this argument by

analysing the performance of the
Quantum Universe companies in the
last ten years and how the stock markets' performance in the same period
has mirrored fundamentals. The graph
here shows the 5-year rolling compounded annual growth rate (CAGR)
in net profit of around 250 companies
and the corresponding return on
Sensex and BSE-100 (a broader index).
Clearly, there is a strong co-relation
between earnings growth and indices
performance.
There are two significant aspects here.
One, the broader BSE-100 index has
outperformed the BSE Sensex by a fair
Tracing fundamentals!

(% change)
25.0%

PAT

Sensex

FY96FY01

FY97FY02

BSE - 100

15.0%

5.0%

-5.0%

FY94FY99

FY95FY00

FY98FY03

FY99FY04

FY95FY04

margin in each of the periods, which

goes to show the benefit of diversification. While this does not mean that
investors should buy 100 stocks, depending upon the age profile and the
investable surplus, a reasonably diversified portfolio will enable investors to tide over the volatility.
The second aspect, in our view, is
even more important. As is evident
from the graph, for the period between
FY98 and FY03, the net profit of all
the companies grew by 18.6% whereas
the Sensex moved up by only 3.9%
(6.7% in the case of BSE-100). This
was a clear case of the markets not
11

recognising the fundamentals. But as

always, fundamentals dictate market
direction and 'valuations' have corrected upwards in the last two years.
This is also the advantage of investing with a long-term view. Though
stock markets may take time to reward
the company for its performance, it is
only a matter of time.
So, where to from here? While the
broader India story of low per capita
consumption, faster GDP growth and
favourable demographic mix still exists,
when the markets are 'hot' (as they are
now), expectations increase manifold.
There are two legs to these 'expectations'. One, the expected growth in
earnings of the company (net profit)
and two, the expected rise in share
price of the company (valuations). As
we have seen historically, when the
markets are bullish, expectations on
both these aspects tend to overshoot.
In the last three months, we have seen
share price target being upgraded by
broking firms even when earnings expectations have been maintained or in
some cases, downgraded! A bull market or a bear market does not change
the fundamentals or valuations, unCORPORATE PERFORMANCE

STOCK
PRICE

THE VICIOUS
CIRCLE

STOCK
PRICE

EXPECTATIONS

less there is fundamental change in

sector dynamics (de-regulation, for
example). It is a vicious circle!

where we are positive with a three-year

view (in terms of valuations and
growth prospects).
1. Oil and Gas: Demand for petroleum
products and natural gas is likely to
increase in the long-term and growth
is visible. Be it refining and marketing
majors, natural gas transmission companies or integrated manufacturers,
the barriers to entry in this sector are
huge. Though standalone majors will
face challenging times in the future
and there will be demand substitution
(gas will eat into naphtha gradually),
we believe that valuations continue
to remain attractive from a three year
perspective. Investing in the energy
sector is basically a call on the government de-regulation, which in our
view, is an eventuality (though not
factored in our estimates). Based on
price to asset value and relative to the
market, we are positive on this sector.
2. FMCG: Despite a competitive environment, given the fact that the investment in manufacturing capacities
and infrastructure is likely to increase,
we believe that the FMCG sector will
benefit in the next three years. Emergence of the 'mall-culture', fast growing services economy and urbanization will expand consumer base as well
as increase consumption of FMCG
products. Margins are, however, likely
to come under pressure. Less asset
intensive nature of the sector, strong
cash flow generation and solid brand
portfolio are other fundamental
strengths. In the sector, we are optimistic on niche players with segmental strengths and few larger players -

probably, the pillars of a retail

investor's portfolio!
3. Housing: We are also positive on
the housing sector, comprising of cement players, paint manufactures and
focused housing finance companies.
Given the shortage of dwelling units
in the country, the market structure in
terms of demand-supply equilibrium
(in case of cement), change in market
dynamics with respect to huge
unorganised segment presence
(paints), there is visibility and growth
opportunity. However, we would suggest investing in market leaders in the
respective sectors as opposed to
smaller players.
To conclude, as the legendary investor Peter Lynch puts it, "Never invest
in any company before you've done
the homework on the company's earnings prospects, financial condition,
competitive position and plans for
expansion. By the way, the odds
against making a living in the day trading business are about the same as
the odds against making a living at
racetracks, blackjack tables, or video
poker. In fact, I think of day trading
as at-home casino care." Remember,
the more you trade, the more your
broker is happy!
This article is authored by
Equitymaster.com, a leading
financial website focused on Indian
equities. It also provides Research
Reports on Indias leading companies and medium to long term buy/
sell stock recommendations.

Having said that, there are sectors

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12

Mutual Funds

Mutual Funds
Equity Funds - The road ahead
In some ways, 2004 set a bad precedent for the equity fund investor. It
spoilt him and set a benchmark for
his expectations. Our advice is - don't
give too much thought to the feelgood moments of 2004; instead ponder over the lessons learnt and in
light of that, plan for the year ahead.
To most investors the 2004 hangover
may be a little too overbearing to look
at 2005 objectively. Admittedly, its
not easy to plan your investments by
simply erasing the amazing stock
market run-up post May 2004. But if
you must ponder over 2004, then
spare a thought to the now almostforgotten "800 plus" point fall that
took everyone by surprise. That the
markets recovered soon enough to
wipe off this erosion is another matter altogether. The point is, investors
had no way of knowing that.
One way to get around the regular
plunge in stock markets is to invest
gradually as opposed to investing in
a lumpsum. Staggering your investments over a period of time makes you
indifferent to stock market fluctuations and also averages your cost of
purchase. This is better known as
'Rupee-cost Averaging', a strategy
we have been advocating for quite
some time now. This was one of the
most important lessons of 2004.
Another lesson that investors may
not have learnt in 2004 but will appreciate in 2005 is the benefit of longterm investing. Most equity fund
managers, including many with
13

whom Personalfn has directly interacted, are of the view that stock market gains in 2005 are unlikely to mirror gains posted in 2004. This implies
that if you are looking at equity funds
with a 6-12 month horizon, you may
have to lower your expectations and
instead increase your investment time
frame. In our view, investors must
look at equities at these levels from a
minimum 3-Yr time horizon. Actually,
investors must always look at equity
funds from any level with that long a
time frame, but more so now.
Diversified equity funds
Choose equity funds with well-defined fund management systems and
controls that ensure the fund remains
well-diversified at all times. Go for
funds that are guided by teams with a
more broad-based decision-making
structure. Skip funds that are driven
by individuals; as fund managers increasingly move from one fund to
another, you don't want to waste time
and effort chasing your fund manager.
Sector funds
If you have been a frequent visitor of
www.personalfn.com then you are already aware of our view on sector
funds. Sector funds go against the
very grain of sectoral diversification,
which is an important trait of mutual
funds. Nonetheless, sector funds do
offer other benefits of mutual fund
investing like stock diversification
and services of a professional fund
manager. So there are a group of investors who can benefit in some way

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from sector funds. However, for that,

you must have an above-average risk
appetite as also an informed view on
the sector. As simplistic as that may
sound, sector fund returns in 2005 will
track those of the underlying sector.
To know more about which sectors are
expected to do well going forward,
read (Beyond the vicious...)
Tax-saving funds
Tax-saving funds is one category that
will never go out of style so long as
tax benefits do not go out of style.
Although
the
Kelkar Committee
has recommended
phasing out of
certain tax benefits like tax rebates under Section 88, it is unlikely that a complete phase out
will happen in
Union Budget
2005. Till then,
tax-saving funds will continue to be a
favourite with risk-taking investors
looking for a tax-efficient investment
strategy. As in diversified equity
funds, look for well-managed, tax-saving funds with well-defined investment processes. Performance over
longer time frames (over 3-Yr) is important as tax-saving funds have a
lock-in and this gives the fund manager the necessary breathing space
to make long-term investment calls.
Tax-saving funds can be expected to
give returns in line with diversified
equity funds if not more, which is 12%
CAGR over 3-Yr in our view.

Balanced funds
Balanced funds are an option for the
risk-taking investor who does not
want to opt for the 100% equity route
or is looking to add stability to his portfolio through a small debt component.
Performance-wise, balanced funds will
grow in proportion to their equity allocations. The debt allocation should
provide stability even during uncertain bond markets given the conservative maturity profiles.
Choose balanced funds that follow a
steady asset allocation strategy.
Typically a 60:40
(equity:debt) proportion is ideal,
but few funds that
stick to this strategy. Most balanced funds can't
get enough of equities during a
stock market runup and hike their
equity components to as high as 70%.

Do not

give too much

thought to the
feel-good moments
of 2004

Regardless of what 2005 has in store

for the equity fund investor, our advice is the same as the one we gave in
2004. Look at equity funds as a means
to generate wealth over the long-term.
Don't panic if equity markets go into a
free fall, if anything, add to your existing investments, since you are
anyways a long-term investor. And at
all times, don't get swayed by stock
market growth, keep an eye on your
risk profile and make sure your equity
fund investments are not out of sync
with your asset allocation.

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14

Fixed Income

Fixed Income
Risk-averse investors: Tough times ahead!
2004 was undeniably a challenging
year for the risk-averse investor. Rising rates meant that investors locked
in long-tenured "assured return"
schemes suffered notional losses;
also the axe fell on schemes like the
6.5% (Tax Free) GOI Bonds leaving
risk-averse investors with fewer options to choose from. In light of such
events, we present strategies for the
risk-averse investor in 2005.
The small savings segment
We at Personalfn believe that the
small savings segment which comprises schemes like the National Savings Certificate (NSC), Post Office
Monthly Income Scheme (POMIS)
among others is due for a significant
overhaul. Not only are the rates (administered at present) likely to be
trimmed down and converted into
market-linked ones, we may also see
some of the schemes being scrapped.
Recommendations to this effect were
made in the report submitted by the
Rakesh Mohan Committee on Small
Savings. While some of the recommendations like scrapping of the 6.5%
(Tax Free) GOI Bonds have already
been implemented, other recommendations could be executed in the
forthcoming budget.

soon; a rationalisation of tax sops

could be on the anvil.
What should investors do?
The new structure of small savings
schemes may not appeal to some investors. Market determined rates
coupled with fewer choices could be
a difficult proposition for investors
used to seeing a variety of high-yielding investment options. On a positive
note, the changes incorporated will
not have any impact on existing investments. Investors can lock-in their
investments at existing rates; this will
insulate such investments from future
changes in interest rates.
Similarly, the Committee has suggested that the Public Provident Fund
(PPF) should be permitted to continue
in its present form. Long tenure and
poor liquidity notwithstanding, investors can allocate a higher portion of
their investible corpus to this scheme.
The fixed deposits segment
Any rise in interest rates can hit those
invested in "assured return" instruments like fixed deposits. A hike in
interest rates implies that existing investors continue to clock returns at
historical (lower) rates, while new investors earn returns at higher rates.
The "fixed" nature of returns could
become a drawback for fixed deposit
investors. Of course, if rates remain
flat or fall, then existing fixed deposit
investors will have made a smart move
by locking their fixed deposits at
higher rates.

Apart from the attractive returns and

high safety levels, tax benefit is another alluring factor. Assesses are
entitled to claim tax benefits under
Section 88 and Section 80L amongst
others, for investments in specified
instruments. This is another area
which may come under the scanner
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15

What should investors do?

Don't invest in long-tenured fixed deposits, say more than 3 years. Secondly, investors could contemplate
getting invested in variable rate deposits wherein the interest rate is
aligned to a specified benchmark rate.
In case of an upward revision in interest rates, investors will be able to benefit from the uptick
Finally, resist the temptation to rake
in higher returns by investing in company deposits; these deposits are unsecured in nature,
therefore investing in the same
entails taking on
higher risk. Stick
to deposits which
carry an "AAA"
rating, indicating
the highest level
of safety, even if
that implies compromising on the
returns.

vesting in attractive "assured return"

instruments to market-linked instruments will have to be made if smart
returns are to be clocked.
What should investors do?
Investors should exercise the option
of utilising the mutual funds route and
investing a portion of their corpus in
hybrid instruments like monthly income plans (MIPs) and balanced funds.
We are not recommending that investors disregard their risk-profile for raking in higher returns; however a small
portion of their
corpus can be invested in marketlinked instruments. As a result, while conventional
avenues like fixed
deposits
and
small savings
schemes would
be the mainstay of
the portfolio and
provide stability
to the same; the portion invested in
market-linked instruments can provide
the much needed impetus.

is unlikely
thatItinvestors
will
rake in higher
returns at
lower risk levels.

Transition to the "market-linked" investments segment

Going forward, it is highly unlikely
that all investors will have the opportunity to rake in higher returns at lower
risk levels. We could see more schemes
like the Senior Citizens Savings
Scheme for instance, which offers attractive returns only to a targeted segment. For a significant chunk of the
investing community, the new mantra is likely to be "take on higher risk,
if you wish to rake in higher returns".
In other words, the transition from in-

Choosing the right investment advisor will be of paramount importance

as well. Select an advisor who is certified, and can provide you with objective advice for investing in schemes
that are best suited for you.
2004 could have set the tone for 2005
and it may not be smooth sailing for
risk-averse investors. Our advice to
investors - gear up for the situation
and take it on the chin!

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16

Interest Rates

Interest Rates

Interest rates in 2005

The interest rate environment for the
year ahead will, to a large extent, depend upon RBI's stance on monetary
policy. In the balance between curbing inflationary expectations versus
facilitating growth, the RBI has
clearly indicated its bent in favour of
the former. Governor Reddy expects
inflation to average at 6.5% by year
end. Correspondingly, however, the
Finance Minister has said before the
Parliament that it will be his endeavour to bring inflation down to 3 - 4%
while ensuring strong GDP growth.
Thus inflation is likely to continue to
be the foremost agenda on the policy
maker's mind next year as well. Hence,
market will also continue to look at
this number closely. Given a higher
rise this year, year-on-year inflation
next year will have the advantage of
a higher base. Also prospects of
slower world growth may have a corresponding benign effect on oil and
commodity prices.
Clearly, one of the key tools for containing inflation (as also highlighted
by both Finance Minister
Chidambram and RBI Governor
Reddy) will be a close watch on and
active management of system liquidity. This implies that call rates will
vary between 4.75% and 6.00% much
more frequently than before which
will in turn induce volatility in the
short end of the yield curve. Over
time, markets may start to price in this
volatility with corresponding pressure on the rest of the yield curve.
From a growth perspective, India re17

mains a strong story as corroborated

by the industrial production data recently, which showed a growth in excess of 10%. Hence it is a very attractive destination for foreign flows as
is being witnessed currently. The
steady flow of dollars implies an appreciating trend in the rupee and in
turn translates into rupee liquidity
given the RBI's intervention. Thus
the Central Bank's task of liquidity
management becomes that much
harder. On the other hand, a stronger
rupee has a correspondingly benign
effect on inflation through making
imports cheaper. Also, from a sentiment point of view a stronger rupee
has a beneficial effect on market participants.

gered a 50 basis point rally in the market. Given the imperative for a stricter
control on finances, the borrowing
programme is unlikely to surprise
negatively in the year ahead as well.
In summary, therefore, we believe that
inflation and RBI's liquidity management will be key drivers next year as
well. While the former is likely to be

advantaged by a higher base and global slowdown, the latter will continue
to be a challenge. Markets will, however, be supported by a more conducive macro-environment. Overall outlook is positive for the next year.
By Rajeev Anand. Rajeev is the CIO of
Standard Chartered Mutual Fund.

The US Federal Reserve continues on

a steady path of measured rate hikes
while emphasizing that monetary
policy remains accommodative. Given
that it still sees 'balanced risks', a view
that is also corroborated by US economic data, it is likely to progress in
'baby steps' peaking at about 3% by
mid of next year. The RBI has clearly
stated that its monetary policy already
factors in international rate action and
to that extent the Fed is unlikely to be
a significant driver of domestic
bonds.
The government's borrowing
programme has come as a positive
surprise this year since it has resulted
in a lesser than expected supply of
bonds. Four auctions have been cancelled in the second half of the calendar year the last of which has trig-

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18

Insurance

Insurance

Innovation will be the key

Ever since the insurance industry was
opened to the private sector, things
began to move in leaps and bounds.
Mostly for the better of course. The
private insurers took huge strides in
terms of services, products, systems
and have not looked back since.
Come 2004 and life insurance looked
totally different than what we have
been used to seeing over the past few
decades. So what more can individuals expect in 2005? We have tried to
predict some trends that may unfold
over the next few years in the life insurance sector.
Increasing awareness of investing in
term insurance
In the past, term plans have not got
their due. A term plan can provide a
larger amount of death cover at a
lower premium. But not many individuals appreciate this or are even
aware of it. What an individual has
to understand is that insurance is not
a pure investment avenue that generates returns; rather it's a risk cover.
The returns part can also be taken
care of by investing in alternate avenue like equity-oriented mutual
funds, monthly income plans (MIPs),
stock markets and even PPF and NSC.
A term plan should be bought as early
as possible when an individual is
young and premiums are lower. We
believe going forward the rationale
will get increasingly apparent for individuals and term plans are likely to
get their due place in individuals' insurance portfolios.
19

Investments in pension plans/annuities set to grow

With the setting up of an interim Pension Fund Regulatory and Development Authority (PFRDA), we are likely
to see positive shift towards better
fund management of pension products. The PFRDA has envisaged setting up of distinct fund managers to
manage pension funds. There will be
separate asset management companies to manage pension assets. Individuals investing in pension plans will
have the option to choose the fund
manager as well as move their investments across fund managers. Awareness levels for investing in pension
schemes and saving for retirement can
only increase in future. Individuals
will consider setting aside a part of
their investment surplus in pensionrelated schemes so as to accumulate
a pool of savings with which they can
buy an annuity at a later stage.

Another pension-related issue where

we can see some clarity is the ongoing debate between 'defined benefit
(DB)' and 'defined contribution (DC)'.
While DB gives an individual a fixed
sum post-retirement, DC defines the
amount of contributions made towards the post-retirement corpus. We
are likely to see a marked shift from
DB to DC, as the policy of defining
contributions is more viable for the
government, which has been hard
pressed to account for the huge outflow of retirement benefits for pension-seekers. In this regard, Ms.
Shikha Sharma, CEO and MD, ICICI
Prudential Life Insurance Company,
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commented, "It has been universally

accepted that defined benefit systems
place immense pressure on the government and its money management.
With most Indian companies now also
moving away from defined benefit
schemes to defined contribution
schemes, it is clear that defined contribution is the most sustainable system".

an increase in business generated

through sales of ULIPs for insurance
companies. A ULIP is comparable to
a mutual fund because both avenues
of investment are market linked. ULIP
works on 2 basic principles:

Initially, the defined contribution

scheme is likely to be made available
only to government employees. Over
time, all private sector employees are
expected to fall
under the DC
ambit.

2. Investing the savings element in

the capital markets to give marketlinked returns.

1. Offering insurance cover to an individual (which is generally lower

than that offered on other insurance
policies for the same premium) and

The coming year

is unlikely to be
very different. Interest in ULIPs is
likely to sustain.
Says Ms. Shikha
Sharma: "Since
their introduction
a few years ago,
ULIPs have established themselves as flexible
and transparent
life insurance products. Customer acceptance of these products - they
contribute over 75% of ICICI
Prudential's premium income - has
been testament to this. Certainly, they
will continue to be amongst the most
popular type of products, given the
many advantages they offer over their
traditional counterparts".

costs
ULIP
need to be

The assured returns, currently at

8.5%, which is the
rate on employee
provident fund
(EPF), will slowly
evaporate. This
means that the
government will
be less willing to take a liability on its
books and let the individual earn a
return by taking on more risk. This is
in line with what is happening in several countries already. However, it is
difficult to say with any certainty as
to how the new pension structure will
evolve or vary from the existing one.

evaluated vis--vis
comparable investment avenues.

Increasing investments in Unit

Linked Insurance Plans (ULIP)
There has been a marked shift in
people's outlook towards variable returns. They have now understood
that 'assured returns' is a concept belonging to a bygone era. This year saw

With increasing competition amongst

insurance companies, a few of them
have managed to reduce the marketing and fund management costs associated with ULIPs thereby enhancing returns for investors. Given the

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20

Insurance

Property

drying up of assured return options,

individuals may want to consider investing in ULIPs to earn above-average returns. But a word of caution ULIP costs need to be evaluated vis-vis comparable investment avenues.
Also ULIPs have a range of options
for investors with varying risk levels.
Take a ULIP only if you have a longish investment time frame (at least 20
years) and have the time and expertise to track equity and debt markets.
Insurers allow individuals to switch
between ULIP options, so it's important for you to be updated so as to
make an informed decision on which
option to choose at a point in time.

based on mortality tables, which in

turn, are structured based on the life
expectancy of individuals in that country. The last few decades have seen
an enhancement in the life expectancy
of Indians through superior medical
facilities and greater health awareness. Unfortunately, the same is not
reflected in mortality tables. The
tables currently in use are still the
ones drawn up by Life Insurance Corporation (LIC) a few decades ago. The
coming years should see mortality
tables being restructured. Restructuring of mortality tables will translate
into lowering of premiums across insurance plans.

Technology usage to go up

Conclusion

As insurers make increasing use of

technology this is likely to add considerable value to both insurers and
individuals. Insurers will have better
systems and more sophisticated products. Individuals will benefit from convenience in terms of more regular updates on their policies, ease of premium payments through ATMs, and
even buying insurance online (at least
one insurer is already doing this for
its term plan).

If one has to understand what lies in

store for the insurance sector, one
just has to take a look at how private
sector banking evolved in the 1990s.
Many were pleasantly surprised at the
positive changes that took place in
the banking sector in terms of customer service, personalised investment solutions, 24-hour cash availability (ATMs) to cite just a few examples. The insurance industry,
though only recently privatised, looks
set to grow at a scorching pace. A
healthy sign of things to come, one
must say.

Restructuring of mortality tables

Insurance premiums are calculated

Property: Where to invest

The Indian economy is expected to
generate a sustainable 6.0-6.5% real
GDP growth rate over the next 2 to 3
years. The service sector is expected
to lead this growth rate and contribute largest to the employment growth
in the country. This trend could have
a positive impact on the property
markets. However there are a number
of downside risks that could adversely affect the outlook for a strong
and sustainable growth rate. First,
increase in oil prices and commodity
prices could lead to increase in inflation resulting in tightening of interest rate by Central Bank. Second, as
the Indian economy gets aligned with
the world markets it will be more exposed to geopolitical and world markets, and to the risks associated with
the same.
With various property types (office,
housing, retail, industrial, warehousing, hotel, etc.); come different property cycles. Economic dynamics directly affect each of the property
types differently. Real Estate is relatively slower to respond to changes
in the economy as compared to many
other asset classes. Knowing the
background of a market and property
type within the market can help determine the risks and cycle length of
a market.
The fundamentals for investing in
property markets remain strong in
India - relatively low interest rates,
strong capital flows, high employment growth, abundant liquidity, attractive demographics (young popu-

21

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lation and migration from West), increase in affordability, and a large

supply of stock to keep up with demand and focus on quality.
Housing Sector
India joined the global housing boom
driven largely by low interest rates
and rising incomes. Never before have
house prices risen simultaneously in
most parts of the World. The question that always comes up is - when
is the housing boom bubble going to
burst.
The housing boom in India continued
its fourth successive year of price
rises. Year 2004 witnessed the sharpest price increase as compared to the
last few years with price rises ranging from 12% to 50% in some regions.
Further the rise in prices has not been
widespread but in selected locations
within the city - basically in centres
of growth.
The supply of residential stock remains strong. In Mumbai itself a
record 30 m square feet will be added
in next 2 to 3 years. The yields of residential properties are now in the range
of 4% to 6%. Investors need to be
cautious in locations where rents
have not moved in line with the sharp
increase in property prices.
There has been a significant improvement in the quality of residential stock
now being introduced in the market.
This has widened the price gap between new and old properties.

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22

Property

Property

The residential sector will continue to

outperform other segments for next
two to three years. But in order to enjoy benefits, it is necessary to invest
in regions with high growth potential
and diversify across metro areas with
different economic structures and
cycles, and not just by region.
Office Sector
Year 2004 marked the revival of office
sector with steady rise in capital values and rental values. This was due
to strong business confidence, expansion announcement by companies,
relocation to new
business districts, growth in
IT and ITES related activities
and opening of
new business
sectors to private
companies (banking, insurance,
etc.). The capital
appreciation recorded ranged
from 10% to 20% with rental yields
now quoting in the range of 9% to
11%.

(both in terms of large space requirement, infrastructure and interiors support). This has dissuaded individual
investors from participating in this
sector.
As interest rates rise there could be
pressure on yields to rise. But the
strong capital flows and demand for
quality investments could add pressure on yields further. Hence, gains
in this sector are expected from identifying new business districts, new regions and new cities that offer investors not only rental returns but solid
capital appreciation.

The housing
boom
in India

Retail Sector

Supply situation
in retail sector
continues to remain strong with
various formats
being introduced
in the markets. It
is too early to
comment on the
performance of this sector as the "mall
mania" is only 5 years old and with
not many reports of secondary sales
in the market.

New class - Mutual Funds

Year 2005 could witness opening of
mutual funds to invest in real estate.
This would provide investors all the
advantages of diversification, exposure to real estate sector with limited
capital, liquidity, greater transparency
and exposure to various sectors, different markets and regions.
Real Estate is by far the world's biggest single asset class. Investors have
much more money tied up in property
than in shares or bonds. Real Estate
is just as prone to irrational exuberance as is the stock market. It should
not be reviewed as an easy way to
make money. People buy property with
the expectation that its price will con-

tinue to rise strongly over time (property is known to be an inflation

hedge). Such expectations lie at the
core of all bubbles formation. Bubbles
form when the price of an asset gets
out of line with its underlying value.
The price you pay for a property
should reflect the future rent/income
at which you let it. As in the stock
market, the prices in real estate are also
driven by sentiments. All that is required to reverse a price movement is
a change in sentiment. Wish you all
happy investing in year 2005.
Sorabh Jain, Director, Mymakaan.com.
Views expressed are personal

continued its fourth

successive year of
price rises.

As large and small scale industries

shift from cities, the office sector in
such cities is predominantly driven by
the service sector. The supply of quality office space has also reduced. New
projects are now being announced
which should be available for occupation by 2006 and 2007.
Investment in office sector now requires large capital outlay due to growing demands of international tenants
23

With opening of FDI in retail, this sector could gather further steam. But
again the investment outlays will remain large. Further the retail sector is
characterised by high maintenance
costs and refurbishment costs which
could eat away the returns. Also the
bond-like nature of retail leases and
high pricing relative to reproduction
costs will make the returns unsustainable in near future.

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24

Gold

KANDIVALI
THANE
POWAI
MULUND
WADALA

PRABHADEVI
PAREL
LOWER PAREL

1556

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1,000

2,018
1,928
1431
2,000

4,000

3,000

2,563

3,504

4,575

4,900
4,950
5,000

6,000

6,750
7,000

8,000

9,000

PRICE (Rs/sq ft)

25

DADAR

1674

2,346

2,856
2,666

3,531

4,625

5,648

6,000

7,533
7,125

PRICE MOVEMENT - Residential (Mumbai)

5,300

SION

1924

2,704
2,529

3,141

4,050

5,200

6,500

6,250
6,044

8,583

YEAR

All that glitters need not be a great investment

Gold is the new favourite of the media. Pick up any newspaper or magazine and there are umpteen reasons
listed in favour of investing in gold.
Unfortunately, this could be just another instance of the media latching
onto an idea whose time has already
come and gone.
The last three years have seen a spurt
in gold prices. Indeed, the performance has been impressive, especially given the fact that in the 1980s
and 1990s gold turned in a poor performance. In 1980, the closing price
of gold was US$ 593.8 per ounce. The
closing price in 2004, after a three
year gold 'bull market', was US$ 442.1
per ounce. This 'safe' investment
surely did not live up to its image!
Investors would have been better off
keeping cash in a savings bank account!
So this rally has come as a relief to
the gold bulls, who were all but extinct. Back in year 2000/2001, few were
recommending gold, when it was trading at about US$ 260 per ounce. Today however, after a 70% rise in the
price of gold, the interest in this commodity has only increased. Our advice to you, be realistic and invest in
gold only to the extent it suits your
risk/return profile.
The comparative table (Table 1) puts
in perspective the returns generated
by different asset classes viz. equity,
debt and gold over different periods
of time. It is important to note that
during these different time periods,

the stock and debt markets have been

through atleast one significant instance of erosion in value. Gold however, has pretty much had a steady
run. Despite this, gold, purely from
an investment perspective, does not
compare well with the other avenues.
Then, why the persistent interest in
gold?
There are a few reasons for the same l The increasing uncertainty pertain-

ing to the US economy and fear that

the US Dollar will continue to
weaken has led investors to move
some money into real assets such
as gold.

l Rising oil prices, coupled with high

liquidity, have contributed to a rise

in inflationary pressures globally.
Inflation, simply put, is an erosion
in the value of money and therefore in such times there is a strong
case to move money into real assets such as gold.

l The

threat of terrorist attacks has

led investors to diversify into assets such as gold, which is considered to be a good store of value (an
attack on the US may cripple the
US economy and result in lower
stock and property prices for example, but will not have a material
impact on the price of gold).

l Then

there is a belief that the longterm bull market for commodities,

including gold, may just be taking
off. This view has been underscored by a persistent rise in the
prices of other commodities too.

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26

Gold

Legal

Indeed, over and above these, there

are 'emotional' reasons why you
should have gold in your portfolio.
But in such instances, the 'return' is
really not that important.

sets, it may present an attractive short

term investment opportunity (like in
1999 when it was undervalued by a
significant margin). So if, and that is a
big 'if', you can identify such an opportunity, an inTable 1: The Face-off: Gold vs Other assets
vestment makes
1 yr
3-Yr
5-Yr sense. Of course
it is important
Diversified Equity Fund 40.0%
65.0%
22.0%
that you square
BSE Sensex
12.3%
26.5%
5.7% off the transacLiquid Fund
5.0%
6.0%
7.0% tion when the
price has corGilt Fund
4.7%
11.0%
14.0%
rected. Such a
Dow Jones (USA)
3.8%
2.7%
-1.1% t r a n s a c t i o n
Income Fund
3.8%
9.0%
11.0% would suit few
investors as it
Gold ($)
2.7%
17.0%
9.3% involves a very
underGold (Rs)
1.5%
13.7%
9.5% good
* Growth over 1-Yr is compounded annualised. Returns for the funds are averages standing of funof best performers
damentals as
well as timing of
In our view, gold is a "must" in every the purchase and sale.
portfolio as it brings in an element of
diversification. The price of gold is But having said that, gold should idedriven by factors which are broadly ally not account for more than 5% of
speaking different from those that your long-term investment portfolio.
drive the price of other assets such as The reason is that in the long term it is
stocks. This results in what is gener- likely that other asset classes, includally seen as a contrararian trend. To ing equities and property, will outpertake an instance, even as stock mar- form gold in terms of generating a rekets corrected after the 9/11 terror at- turn. While this may not hold true for
tacks and the worsening economic economies like the US which are likely
outlook, the price of gold spurted.
to slow down in the future, surely for
investors in markets such as India,
Another argument in favour of gold other investment avenues are more
is that from time to time, like all as- beckoning.

Will these tax provisions change in 2005 ?

The Income Tax Act runs over 950
pages with an assortment of 298 sections. There has always been a lot of
litigation regarding the interpretation
of this Act. Every year the Finance
Minister under the guise of bringing
simplification makes the act more
complicated.
Lets delve into an expert's mind as
he dreams of brighter days of I-T in
India.
Exemptions and Deductions
Exemptions are stated under Sections
10, 10A and 10B of the Act. Chapter
VIA deals with deductions from the
taxable income. Some sections give
benefits for the carry forward of
losses of the earlier year, unabsorbed
investments allowance and unabsorbed depreciation of the earlier
year. The present Finance Minister
will, hopefully, bring in some appreciable change.
Instead of the ineffective two prong
strategy of giving deduction and
charging high taxes the government
may rationalise this by removing the
benefit of deduction /exemption
along with reduction in tax simultaneously. This will also lead to the reducing of unnecessary litigations.
Investment schemes
Sections like 80CCC, 80L, 88 and others give benefits to assessees who
invest in certain schemes. The government may soon modify these sections by putting all schemes under
one section and the investor will be

27

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free to choose the scheme he prefers,

encouraging free play between the
market players.
The mutual funds and small investment schemes would be able to give
their best performance since they will
be competing against each other. In
the alternative, the government may
remove all these benefits under Section 88, 80CCCand 80L and reduce the
rate of taxation or increase the minimum threshold limit for the purpose
of tax.
E.g. the minimum limit of Rs 50,000
may be increased to Rs 65,000.
Taxation in other countries
The government could follow polices
such as those laid in countries like
Dubai. A person would be required
to calculate his wealth at the beginning of the year and also to calculate
at the end of the year. The increase in
the wealth would be subject to taxation. In this case, there will be no income tax but tax on the increase
wealth.
In countries like the US, the government gives benefit to a person who
has earned income, if he invests that
sum into acquiring further business
and reinvesting in the business. This
helps business growth and creates
more employment opportunities. It
increases the availability of goods in
the market. Hence, there will be reduction in price due to competition.
On the tax front, the government can
earn on the federal tax.

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28

Legal

Legal

Transaction Tax
The government introduced the Securities Transaction Tax (STT) last
year. Under this tax, every time a person purchases or sells shares, he has
to pay tax, which is insignificant i.e.
0.15% or 0.075%.
In lieu of that, his long term capital
gain on shares is not taxable and his
short term capital gain on shares is
taxable at a lower rate of 10%.
The government may apply the STT
to all the sectors
and Sales Tax,
Custom, Excise
Duties and all
countervailing
duties etc. may be
abolished. Those
who undertake
more transactions
will pay more tax.
Those who do
not carry out any
transactions
would have to pay
a lower tax since the quantum of transactions done by them would be lower.
This would find favor with people who
preach secularism as the rich will automatically be taxed more than the
poor.

Agricultural income and other exempt incomes

Any person, who earns income, including agricultural income, would
necessarily be required to file his return of income, together with his profit
and loss account, balance sheet and
capital account. A lot of people claim
income from agriculture where no agriculture exists, thereby converting
their black money into white and show
it as an agricultural income. Once they
file returns, and their returns are scrutinised, only the real agricultural income would then
become tax free.

Government
may
apply the

Earlier the benefits of 100% tax

and exemptions
under Section 80
HHC were available. These deductions were
phased out from
80% to 70% and
subsequently
withdrawn, as a
result of which the accounts of these
individuals came under scrutiny. The
IT department found that suddenly
the export G.P. had come down and
so did the quantum of transactions.
This had raised a serious doubt about
the misuse of the Section. Therefore,
the accounts of all exporters may
soon come up for scrutiny.

transaction tax
to all the
sectors

Once the tax is levied on the principal

amount, the collection and payment
would also be easier as it would be
inbuilt in the cost of any product. The
entire system of maintaining of IT
records, departments and officers will
not be required. The load on the exchequer would be greatly reduced.
29

At present, it is a builder's paradise.

Section 80IB (10) gives total tax exemption to builders who construct
residential houses. This benefit was
given to ensure that low cost housing was provided to the community

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at large. None of that has happened.

The builders who have shown huge
profits have usurped the entire profit.
This is already under the
government's magnifying glass.
Computerisation
Soon the government would require
all transactions above Rs 20,000 per
person, per year to be made through
the bank accounts where the PAN of
the persons would be noted. This
would curtail the use of black money
for all transactions.
Tax Deducted at Source (TDS)
It has been seen that the provisions
of TDS have helped a lot in the collection of tax. E.g. if a small contractor or transporter is paid a sum, such
a person would generally never file a
return or offer income for taxation.
People like the taxi driver or the owner
of a paan/beedi shop may earn a lot,
but do not pay any taxes, nor do they
contribute to the exchequer in any
way. Soon, a system could be put in
place, which ensures that tax is deducted at source by the payer, so that
at least some portion gets taxed.
Interest mandatory
The Supreme Court, in the famous
case of Anjum Ghaswalla has held
that the Income Tax authorities do not
have any power to waive or reduce
interest under Sections 234A, 234B
and 234C. Thus, the interest is mandatory.

Service Tax
To date, the service tax is levied on
certain specified activities i.e. all other
activities are exempted. A lot of litigation has arisen as to whether a certain activity is taxable or not. If, taxable on what portion or to what extent.
However, the next budget would
change the entire scenario. If there
would be a service tax on each and
every activity, there would be a lot of
income generated for the government.
Service tax has been a bonanza for the
government. If you buy a product, you
pay excise and sales tax. If you import
a product, you pay customs. Similarly
if you buy a service, you pay service
tax. The government has used this
logic and in the next budget, all services would be taxable, except those
specified services, which would be
exempt.
Unfortunately, the common man
would have to collect, pay tax to the
government and spend a great deal of
time and money on the maintenance
of record. If he defaults in any manner there would be serious consequences in the form of huge piling up
of interest and penalties.

By www.legalpundits.com. Legalpundits
is a leading one-stop site for all your
legal queries.

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30

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