By a stock market analyst
The performance of the Colombo Stock Exchange (CSE) has become a debatable subject matter in society. The upward trajectory of nearly 11 percent recorded during the months of March and April has gradually declined. The average daily market turnover that was recorded as Rs.1,059 million last year has reduced to Rs.747 million in 2016. The heavy price of the depressed market is felt severely by investors and stockbroker firms. Hence, it is timely to penetrate into the lamenting saga of the stock market.
Many expected the rainbow revolution (political transformation in January 2015) to revive the stock market. Yet, to the despair of many, the market failed to deliver as expected. Nearly one and a half years have passed and the market momentum continues to be fragile. Where did we fall short?
Where did we fall short?
The answer draws its roots to various interwoven factors. The Securities and Exchange Commission of Sri Lanka (SEC) Chairmen and the CSE have elaborated on factors that influence the current market trend in recent interviews. Further on, National Policies and Economic Affairs State Minister Niroshan Perera shed light on the current market trend in parliament last week. Accordingly, it is believed that the global economic activity that remained subdued, economic slowdown in China, rapid decrease in world oil prices, US Federal Reserve’s decision to increase rates by 0.25 percent, surge of terror attacks (ISIS), socio/political and economic issues emanating from mass migration in Europe and the uncertainty attached to Brexit resulted in widespread uncertainty. Foreign investors are compelled to divest their funds from equity and focus on fixed return instruments.
The policy decision of the Central Bank of Sri Lanka to increase interest rates coupled with the depreciation of the currency would have continued to reduce the appetite towards equity. One could not negate the impact of political fragility that emanated from the presidential and parliament elections that were held last year. The fragile political condition would have influenced investors to contemplate on actively participating in the market.
A rational and critical investor will transcend the aforementioned reasons and question the policy stance of the government. Did the government policy stance adequately encapsulate a pro-market approach?
The government with all its expertise failed to adopt a long-term and consistent policy stance towards the betterment of the capital market. It has been manoeuvring fiscal policy (taxes) according to its own whims and fancies. The government has failed to provide consistent fiscal policy direction.
Initially, last year’s budget proposed to abolish the transaction levy of 0.3 percent. Stock market trades are subjected to a transaction costs. Transaction costs comprise of broker’s fee (brokerage), SEC fee, CSE fee, Central Depository System (CDS) fee and transaction levy (the transaction levy is imposed by the government on both purchases and sales). Perhaps the government would have expected to boost the market through this initiative. Market sources confirm that the SEC or the CSE did not make any representations on the matter. Neither did investors show any objection towards the transaction levy.
The removal of the transaction levy was followed by certain signals on introducing a capital gains tax on stock transactions. A capital gains tax is a tax on the profit realized on the sale of an asset that was purchased at a cost that was lower than the amount realized on the sale. The dilemma of a capital gains tax on equity is far reaching. The situation intensified as the government reintroduced the transaction levy in April 2016. Why did the government remove the levy if they were to reintroduce it? Such inconsistency in policy is detrimental towards the growth momentum of the market. Similar approach was seen when value-added tax (VAT) was increased. There were varied representations within the government on the subject matter. It is believed that the VAT structure will be amended further.
Sadly mistaken policymakers
With time the government once again started speaking about the capital gains tax. It was discussed in parliament that this tax is expected to tap individuals who became millionaires from the market. Yet, policymakers were sadly mistaken. Most people who earned a fortune through the market during 2009-2011 are no longer active in the market. They have already earned their fortunes. Needless to say some increased their profit margins by artificially manipulating the market. Currently, the market is the preferred choice of average investors. It is unlikely that the class of investors the government intends to tap would re-enter the market in the immediate future. As a capital gains tax cannot be levied in retrospect its relevance in the market is questionable.
Further on, calculating a capital gains tax in the stock market is a tedious task. It is rather complex. Investors purchase shares at different price levels and sell under different market conditions. It is not as simple as purchasing a house/fixed asset. It is also reasonable to question the implementation of the tax in the absence of a designated authority to calculate the complex tax structure. It will be rather cumbersome if not impossible for the CSE to facilitate tax collection. On the other hand, handing it over to a different agency will warrant a large number of data to be transferred, which in turn would result in an array of other technical and legal difficulties.
It is difficult to perceive the expectation of the government by imposing a tax of this nature. The prime minister on various occasions endorsed the importance of increasing stock market penetration among the middle class and rural sector. The government undoubtedly expected to boost market operations. Some of these initiatives should be acclaimed. Yet, why does the government hinder the growth of the market through inconsistent policies? Who is advising the government on tax proposals?
Where revenue proposals are concerned, the government must seek advice from economists who are well versed in the subject matter rather than from tax consultants who will try to make the proposals complicated as possible so that they will have more clients to advice. It is certain that the government lacks long-term oversight and has failed to give due consideration to the capital market, which is a live wire of the economy.
The government flamboyantly speaks about taxing market makers who earned a fortune through the market, yet they have not mentioned the tax structure. Even though a few months have passed the applicability of the tax to the capital market remains a question. The uncertainty will divest investors from the market. The public is left in the lurch and is compelled to rely on unofficial statements made by the Cabinet ministers.
Twofold role of SEC
Cabinet Minister Patali Champika Ranawaka informed the foreign correspondents two weeks back that a 10 percent capital gain tax will be applicable to the stock market. The minister is in charge of Megapolis and Western Development. He is not the minister in charge of the subject matter and neither is he the government spokesman. On what basis is he making such statements?
Ideally, information of this nature should be disclosed by the National Policies and Economic Affairs Minister or Finance Minister. ‘Reuters’ newswire carried this information on June 28, 2016 and its impact on the market was appalling. The market that was poised upwards on that day experienced a drastic drop in prices after the news was released. It is not an overstatement to mention that the market is in chaos.
The importance of revenue generation to avert the economic slowdown cannot be undermined. According to the Central Bank annual report 2015, total government debt to gross domestic product (GDP) ratio increased to 76 percent by the end of 2015. The prime minister once mentioned in parliament that the public debt of the country is more than Rs.9.5 trillion. Except for a few members of the joint opposition there is consensus on increasing tax revenue in order to pay up the massive debt. However, the tax structure should be underlined by a cost benefit analysis. If not, it will only accelerate economic slowdown.
The stock market has declined by 8.5 percent for the current year. Introducing the capital gains tax will accelerate the downward trend further. The stock market signals the financial health of the economy to foreign investors. The deliberate action of the government to push down the market would contradict its policy to attract foreign investments.
Moving on, revenue generation of the capital gains tax is also questionable. Transaction levy is charged when purchasing as well as selling shares irrespective of earning profits. However, the capital gains tax will be levied only if an investor generates profits. Further on, the government earned Rs.1,507 million last year and has earned Rs.13.8 billion during the last 10 years through the current transaction levy. It could be reasonably postulated that the transaction levy will be the optimal choice. If interested, the government could marginally increase the transaction levy that currently lies at 0.3 percent.
Given the current state of affairs, the role of the SEC is twofold. It is pivotal that it convinces the government to adopt a consistent fiscal policy stance and refrain from imposing the capital gains tax on the market. Reliable sources reveal that the SEC has lobbied heavily against the implementation of the capital gains tax. It is equally important that the SEC continues and accelerates its endeavours in tracking down market offenders (especially those who involved in manipulating the market in 2010/2011). It is vital to understand that tracking down as well as punishing the wrongdoers can be time consuming, predominantly due to the intricate nature of a capital market and the nature of malpractices.
The people’s mandate called for political revival and equitable economic growth. Commendable progress is made in achieving international recognition and freedom of speech/thought. The government has created a suitable environment for people to speak and act freely. However, the public is left dumbstruck in terms of economic vision. Economic mismanagement from a United National Party (UNP)-led government was least expected. Lack of far sightedness and the absence of consistent policies have affected the economic wellbeing of the people.
In conclusion, it is important to reiterate the dire need of adopting consistent policies to prevent the stock market and the economy falling down the precipice of instability and turmoil.