Arbitrage funds help in volatile market

 

            Fund managers try to take advantage of differentials in current prices and future prices of a security. For example, a fund manager can buy shares in the cash market and sell the same stock and the same quantity in the futures or derivatives market, earning the differential without taking any risk.

This can be further explained with an example. Let’s assume that stock A is trading at Rs 100 in the cash market but the price of futures expiring next month is Rs 105. So fund manager will buy the specified quantities of the stock in cash and simultaneously sell in the futures market. Thereby earning a return of Rs 5 when the settlement takes place on expiry. A reverse transaction is also possible if the prices in the futures market of security are lower than the cash prices.

Thus, market volatility is a great friend of Arbitrage Fund Manager, as the differentials between cash and futures markets tend to amplify during the periods of volatility. Also, speculative activity is on the rise during the period of market volatility, so demand for security in the futures market could be higher than in the cash market, leading to a higher differential.

Arbitrage Funds also keep some part of funds in the high-quality debt and money market instruments to provide stability to returns. This also helps them ready availability of funds in case there is a sudden opportunity to be exploited.

During the current phase of the low-interest scenario, most short-term instruments like Liquid Funds are generating low returns of around 3 percent pa. Similarly, returns on short-term bank deposits are also very low.

While the Arbitrage Funds are able to generate higher returns in the range of 5-6 percent pa taking advantage of the volatility in the market. Stock markets have been volatile in recent months due to both negative and positive news flows. On one side, there has been uncertainty about the economy due to the massive 2nd wave of Covid, on the other hand, there is a lot of liquidity driving the market along with the expectation that economy will recover faster than anticipated.

Taking advantage of the situation, smart investors have started moving money into Arbitrage Funds from other short-term avenues. Liquid Funds saw a net outflow of Rs 45,000 crore in May 2021. While Arbitrage Funds saw a net inflow of Rs 4,520 crore in the same month.

Arbitrage Funds also offer a tax advantage over other short-term avenues like Liquid Funds of Bank Deposits. Arbitrage Funds are classified as Equity Funds, hence the short-term gains are taxed at 15 percent while gains accruing after one year of holding attract a tax of just 10 percent, that too for a gain of more than Rs 1 lakh during a financial year. However, returns on Liquid Funds or Bank Interest Income is taxed at marginal tax rate for up to 3 years, which means investors in high tax bracket will pay much higher taxes on these options.

So Arbitrage Funds definitely are a great option for parking short-term funds as long as the market volatility continues!

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5 benefits of filing ITR even if your income is not taxable

 

                There are many benefits pursuant to filing the tax return even if you earn below the taxable limit.

Filing of tax returns in India is mandatory for individuals only when their taxable income exceeds Rs 250,000. Besides, individuals paying towards consumption of electricity more than Rs 100,000 or those who have undertaken foreign travel for over Rs 200,000 are also required to file a tax return. However, there are many other benefits pursuant to filing the tax return even if you earn below the taxable limit. Here we are taking a look at some of them:

1. Claiming a tax refund

Certain passive income such as term deposit interest or dividend income suffers tax withholding. For many individuals these could be exempt if it is below the threshold. “Most of the individual taxpayers having only the above-mentioned income would need to file the tax returns for claiming refund of taxes. Even in the cases of salaried taxpayers where excess taxes are withheld, filing of returns would be mandatory to claim the refund of excess taxes. By filing an ITR online, the refund of taxes can be claimed in the individuals bank account that is KYC-compliant,” says Sudhakar Sethuraman, Partner, Deloitte India.

2. Processing of Documents

Income-tax return is a key document for the purpose of processing applications for various purposes. For example, at the time of lodging an application for processing of a house or auto loan, bankers seek the copies of tax returns filed to verify the individual’s sources of income. The tax returns filed on prudent basis help in smooth processing than having to explain why returns for certain years were not filed. Besides securing a loan, the income tax return helps in the processing of obtaining credit cards, insurance policies, etc.

3. Application for VISA

Where individuals are planning to take up a job or conduct business visits outside India, the immigration authorities request for copies of tax returns filed in the past. The tax return filing ensures in smooth processing of VISA applications as immigration authorities then deem the individual as tax-compliant. It is seen that certain embassies that of the US, Canada, the UK, etc. are particular about the tax return records of the individual.

4. Claiming losses

Filing of tax return within the due date is mandatory to claim specified losses for an individual taxpayer, such as losses from capital gains, business, or profession, etc. “By opting to file tax returns, not only does it benefit the individual to claim the losses carried forward in future years, but it also serves as a document to track losses that can be claimed in the future. For example, an individual taxpayer who makes a profit from the sale of mutual funds or equity shares can adjust these profits with losses incurred in the past by filing tax returns on time,” informs Sethuraman.

5. Serves as Proof of Income

Self-employed taxpayers do not have any proof of income unlike salaried individuals who receive a salary certificate in Form 16. Therefore, the income tax return serves as a proof of income for these self-employed taxpayers with detailed break-down of income and expenses incurred by these individuals during any financial year. Besides, self-employed taxpayers can also furnish these documents before various forums as proof of income.

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Forex reserves holding of central bank and its impact

 

            The Reserve Bank of India (RBI)’s foreign exchange reserves have been increasing sharply, suggests new data. Since April 2020, the RBI’s dollar reserves have grown by over $100 billion to now stand at $608 billion, making India the fifth-largest reserve holding country in the world.

The central bank has justified its forex intervention by talking about reserve adequacy. It has been argued that the RBI does not hold more than 15 months of import cover while some countries hold more. Switzerland, Japan, Russia and China hold more reserves than India and their import covers are 39 months, 22 months, 20 months and 16 months, respectively.

However, over the last two decades, the RBI’s forex intervention has been motivated by concerns about currency movements.

Eye on currency, but conflict with inflation targeting

The recent increase in reserves has been prompted by an attempt to prevent large rupee appreciation. In June 2020 the rupee-dollar exchange rate stood at 75.6 while now it is around 72.8, a small appreciation. Intervention helped prevent a larger appreciation.

Not only does such currency manipulation invite the ire of other nations, it is costly as it is inflationary.

Moreover, if there is a serious speculative attack on the currency, reserves are not used to prevent depreciation. In the past, the RBI has tightened monetary policy and used capital controls in order to prevent the rupee from falling, instead of selling off its billions.

The central bank does not want the rupee to appreciate as that makes exports uncompetitive. Hence it intervenes in the forex market to buy dollars.

Such a course of action, as adopted by China for many decades, is seen as a “beggar thy neighbour” policy because it makes other countries worse off. This is not looked upon kindly.

In April this year, the US decided to retain India on its watchlist of currency manipulators. India had been on this list since December 2020.

The US puts countries on the list of manipulators if they meet two of the three criteria over a 12-month period: (a) bilateral trade surplus with the US of over $20 billion; (b) current account surplus of at least 2 per cent of GDP; (c) net purchase of foreign currency amounting to at least 2 per cent of the country’s GDP.

According to the US Treasury Department’s report released in April, India was kept on this list because the RBI’s net forex intervention amounted to 5 per cent of GDP in the previous 12-month period, and because India’s bilateral trade surplus with the US had exceeded $20 billion.

Among the many costs of RBI’s currency intervention, an important one is that adding to its forex assets increases the money supply in the domestic financial system.

An expansion in the money supply exerts inflationary pressures which might be damaging for the economy.

Are forex reserves held for preventing currency weakness?

One of the reasons a high level of reserves is considered useful is because it gives the central bank enough ammunition to fight against future currency depreciation.

If the currency starts depreciating against the dollar, then the central bank can sell its dollar reserves and buy the local currency in order to stop the depreciation. But this rarely happens in the case of a speculative attack on the currency.

With the US economy overheating due to the massive fiscal stimulus implemented by the US government, inflation in the US is on the rise. This could prompt the US Federal Reserve to start raising the policy interest rate.

If that happens, the situation for emerging economies like India will be similar to the Taper Tantrum episode of May 2013, when the US Fed had signaled a tapering of its Quantitative Easing policy. This had led to capital outflows from India as well as other emerging economies causing their currencies to depreciate.

Defending the exchange rate by selling reserves invites speculators. When people see that the RBI is selling reserves, they expect that when reserves will fall to a very low level, the central bank will be forced to stop intervening and the currency will weaken. Foreign as well as domestic investors start taking money out before this event materializes. Their speculative attack on the currency ends up hastening the currency depreciation.

During the taper tantrum, to prevent depreciation, the RBI tightened monetary policy, squeezed liquidity from the system and imposed capital controls. It used a very small part of its reserves.

In May 2013, RBI’s forex reserves were at around $288 billion. Between May and September, 2013, it sold roughly $22 billion. Even so, the rupee witnessed a sharp depreciation from 56.5 in May 2013 to 62.8 in September 2013.

The central bank’s build-up of reserves lets businesses believe that the rupee will not weaken sharply. They think that RBI’s stock of reserves will be used against big currency fluctuations. This in turn prevents these firms from hedging the dollar exposures on their balance sheets.

It creates a never-ending vicious cycle wherein the more RBI hoards, the more confident these firms become to take unhedged exposure, thus avoiding the costs of hedging and then the greater the justification for the RBI to hoard reserves.

(Source : www.theprint.in)

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