Why the Rajiv Gandhi Equity Scheme will be a resounding flop

Bad ideas always seem to have a strong market among politicians. A case in point is the Rajiv Gandhi Equity Savings Scheme (RGESS), a scheme that is supposed to entice first-timers to invest in equity by giving them tax concessions.

The idea of RGESS, presented in Pranab Mukherjee’s last budget, is that new investors in stocks will be given a 50 percent tax deduction on investments upto Rs 50,000. The scheme, which will be open only to investors earning upto Rs 10 lakh per annum (aren’t there first-time equity investors earning more than Rs 10 lakh?), and the money will be locked for three years.

[caption id=“attachment_378472” align=“alignleft” width=“380”]  GESS is being offered like a one-time lottery for those who have never invested in equity, and who will never be allowed to participate in RGESS again. AFP[/caption]

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To make sure that India’s equity-challenged investors do put their money in RGESS, the government is now thinking of tinkering with the norms and allowing a shorter lock-in period than three years. But one thing it will not relent on is allowing any investor to participate in the scheme more than once.

In short, RGESS is being offered like a one-time lottery for those who have never invested in equity (how will they find out, by the way?), and who will never be allowed to participate in RGESS again.

A more daft way of promoting equity investment cannot be thought of. Only mandarins in North Block could have come up with such an idea.

Let’s look at the philosophical inadequacies of the scheme, before critiquing its nitty-gritty. Let’s assume the government wants to promote equity investing among the general public.

The first thing to understand about equity is risk. No one should invest in equity without being aware of the risk that equity bears. If this is the case, is it right for a government to promote the taking of risk by first-timers - even with the help of a fund manager - by using tax as inducement?

The second incongruity about RGESS is glaring: when the government won’t allow its own provident and pension funds to invest in equity, why encourage individuals to do so? Of course, the New Pension Scheme launched in 2009 allows savers to invest in equity, and even higher amounts depending on their risk-taking capacity, but isn’t this then the route to recommend to savers?

The third point is the silliness of it all. When Equity Linked Savings Schemes (ELSS) already offer 100 percent tax deductions upto Rs 1,00,000 (of course, along with other investments in PF, insurance policies, etc), what is the point in offering another scheme with 50 percent deduction for first-timers? And remember, ELSS can be used every year, unlike RGESS.

The fourth point is the possibility of mis-selling. Like unit-linked insurance plans (ULIPS), where the skewed incentive structure makes companies sell ULIPs like mutual funds, RGESS will obviously be sold like a tax-saving scheme rather than a genuine risk-bearing scheme for long-term investors. And if the idea is to reduce the lock-in period to make it attractive, then the chances of it being sold as a tax-saver rather than an investment scheme will be even higher. Needless to say, the idea of getting people to take to equity will be lost in the thicket.

The fifth point is the possibility that RGESS will be almost impossible to administer. How is the government going to monitor whether you are a first-time investor or a pro? If you are going to demand huge KYC proof and documentation, the scheme won’t take off. If you are not going to do that, then many more people than just first-timers will get in. People will invest through their children, minors, or relatives.

Who, in any case, if a real first-timer? If the idea is to exclude people who already invest directly in equity, one should consider even investors in equity mutual funds as non-first-timers. Will they be excluded?

Moreover, what is the point is saying that RGESS can be used only once? If I have invested Rs 50,000, and I am happy with my decision, shouldn’t I be encouraged to invest more, maybe with lower tax benefits?

Let’s also see what has been the success of the ELSS scheme, which is tapering off into irrelevance, despite superior tax benefits.

In the January-March quarter of this year, there were 49 schemes in existence, and their collective corpus was all of Rs 1,132 crore. That’s down from Rs 1,696 crore from a year ago. Clearly, people are bailing out of even a superior scheme.

Even assuming the RGESS exceeds initial expectations, the chances are it will have succeeded for the wrong reasons. And hence could be risky for investors in the long run.

As we have argued before , the best way to get more money into equity on behalf of the aam aadmi is to route a small portion of long-term savings from pension and provident funds (with safeguards) so that they benefit from any upside in the equity markets.

So RGESS is really one more bad idea waiting to die an unsung death. Maybe RGESS should be spelt REGRESS. Wonder why a government led by Rajiv Gandhi’s widow would want a lousy scheme named after him.