Press reports seem to suggest that, the Indian Finance Minister, P Chidambaram intends to increase the tax rate on dividends distributed by fixed income oriented mutual funds, in his budget proposals to be unveiled on February 28.
Such a move, if it fructifies, would come after intense lobbying by the banking industry, demanding parity with mutual funds on tax treatment.
It is significant to note that aggregate deposits of the banking system is well in excess of Rs. 25 trillion (USD 600 bn approx.) while the size of the fixed income oriented mutual funds is approximately Rs. 2 trillion (USD 45 bn). It is also notable that the banking industry has added in excess of Rs. 3 trillion in deposits in the last 11 months, 50% more than the entire size of the fixed income fund industry.
What makes bankers feel threatened by the growth of mutual funds is beyond comprehension.
Currently, a significant portion of the mutual fund portfolios actually comprise instruments issued by banks. This has been an efficient source of funds for banks, on the lookout for wholesale funds to boost balance sheet size.
Mutual funds have been acting as efficient intermediaries for banks in this respect. Any removal (or dilution) of the slim tax advantage that funds enjoy would only lead to inefficiencies in resource mobilisation for banks themselves.
Mr. Chidambaram should also recall that his dream budget of 1997, which exempted dividends from tax, actually gave a big fillip to the mutual fund industry, paving the way for a vibrant and active market in debt instruments.
Further, the tax advantage enjoyed by mutual funds over bank deposits is only marginal and is likely to be of import only to large and fickle investors. In a way banks are saying, these large sums of money is what we need to lay a hand on to show growth. What they probably do not forsee, is that they probably already have a recourse to these funds, via mutual funds.