Markets witnessed a significant downturn as foreign portfolio investors (FPIs) withdrew close to $1 billion from the Indian equities segment just two days following the announcement of a revised tax treaty between India and Mauritius. This considerable outflow led to a sharp fall in domestic equity benchmark indices by more than 1%.
The stock market was not only reacting to internal fiscal policy adjustments but also to unfavorable international trends. Higher than anticipated U.S. retail inflation figures quashed the previously held optimism about imminent interest rate cuts by the Federal Reserve. Concurrently, the increase in the US 10-year yield added to the bearish sentiment.
On the home front, provisional data from the Bombay Stock Exchange (BSE) indicated that on Friday, FPIs sold off equities amounting to Rs 8,027 crore on a net basis. Domestic institutional investors (DIIs), on the other hand, made purchases worth Rs 6,341.53 crore, preventing a more severe market nosedive.
Indices took a hit with the Sensex dropping by 793 points, which is a 1.06% decline, to close at 74,244.9 points. The Sensex faced an even steeper drop during the day, with intraday trades seeing an 849-point fall. The broader Nifty couldn’t escape the bear hug either, closing at 22,519.4 points, lower by 234.4 points or a 1.03% decrease.
At the core of these financial convulsions lies India’s move to amend its Double Taxation Avoidance Agreement (DTAA) with Mauritius to curb tax treaty abuse for evasion or bypass. A notable inclusion in the amended treaty is the Principal Purpose Test (PPT). The PPT posits that the tax benefits accorded under the treaty would be non-applicable if it’s established that the primary purpose of any transaction was to gain that tax benefit.
Historically, May 2016 was when the treaty last saw a modification, which granted India the right to tax capital gains arising from the sale or transfer of shares in Indian companies held by a Mauritian resident, cumulatively exempting investments dated up until March 31, 2017, from this tax.
Commenting on the repercussions of both the DTAA revision and global financial indicators, Asit C Mehta of Investment Intermediaries Ltd. shared, “Indian equity benchmarks fell sharply on Friday, driven down by global market mood, as high US consumer price inflation data damaged the potential of an early rate cut by the Federal Reserve. Moreover, the alterations in the Mauritius tax treaty with India have had a significant bearing on market confidence.”
Although the treaty with Mauritius was formally amended on March 7 in Port Louis, details were only disclosed to the public on April 10. This amendment has left room for ambiguity regarding whether past investments are to be grandfathered, with the financial community keenly waiting for additional guidance from India’s Ministry of Finance.
India’s relationship with Mauritius has been vital in the investment domain, given that Mauritius is ranked as the fourth-largest source country for FPI inflows, following the US, Singapore, and Luxembourg. The total FPI investment funneled into India via Mauritius was recorded at Rs 4.19 lakh crore at the end of March 2024, making up 6% of India’s cumulative FPI investment pie.
Adding to the narrative, Joseph Thomas of Emkay Wealth Management observed that the Indian stock market emulated the global trend, specifically taking cues from the US, where a slight uptick in the consumer price index was prematurely perceived by market participants as a blockade to future Federal Reserve rate reductions.
The US consumer price index climbed by 0.4% on a seasonally adjusted basis and saw an annual increase of 3.5% in March, an uptick from 3.2% in February and surpassing the forecasted figure of 3.4%. At the close of the previous year, the Federal Reserve had signaled it might enact three rate reductions in 2024. But, as highlighted by a Bank of Baroda report, the latest surge in inflation bolstered the Federal Open Markets Committee’s stance that more evidence is necessary to confirm the durability of any decline in inflation.
The US bond yield saw a substantial rise, hitting 4.51%, while veteran banker Uday Kotak sounded alarms over the persistent high inflation in the US, suggesting that rate cuts might be pushed back to near the US Presidential elections. His cautionary words pointed toward sustained high-interest rates globally, inclusive of India.
Last week, the Reserve Bank of India held the repo rate steady at 6.5% amid concerns that food inflation might derail their disinflationary path, signaling caution and readiness for potentially challenging economic waters ahead.
