Budget 2025: Will tax reforms boost India's bond market?

As Budget 2025 approaches, the anticipation surrounding potential tax reforms is palpable. This year’s budget holds particular significance for India’s financial markets, as stakeholders eagerly await signals on economic priorities. With a renewed focus on fostering growth and investment, the proposed tax reforms could have far-reaching implications, particularly for the bond market, a cornerstone of India’s financial infrastructure. But will these reforms truly transform the bond market, especially the corporate bond segment? Let’s delve into the expectations, potential proposals, and their probable impact.

Prevailing expectations: Voices across the spectrum

General Public

The Indian middle class, often referred to as the backbone of the economy, is eyeing this budget for tax relief measures. Many hope for adjustments to income tax slabs and higher deductions under Section 80C & 80D, freeing up disposable income to explore diversified investment avenues, including bonds.

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• Income tax relief: Potential revisions in the basic exemption limit and restructuring of tax slabs could boost disposable income, encouraging retail investments in bonds.

• Higher savings deductions: Increasing the cap on Section 80C & 80D could drive greater interest in fixed-income instruments, especially debt mutual funds and bonds.

Financial markets

Market participants are keenly observing for structural reforms to improve liquidity and transparency in the bond market. Taxation clarity and measures to enhance retail participation are among the key expectations.

• Focus on debt mutual funds: Reinstating indexation benefits for debt funds and addressing taxation disparities could revive investor confidence in the segment.

• Boosting retail engagement: Targeted incentives for investments in corporate bonds might deepen participation among retail investors.

Finance experts and investment professionals

Experts emphasise the need for policies that support long-term capital formation. The corporate bond market could gain significantly from reforms aimed at simplifying issuance and taxation.

• Reintroduction of Tax-Free Bonds: These instruments could attract long-term investments, aiding infrastructure growth while offering stable returns.

• Tax rationalisation: Equalizing tax treatment across asset classes could help level the playing field between equity and debt instruments.

Tax professionals

Tax experts advocate for simplified, uniform taxation of financial products to eliminate distortions and foster investor confidence. Incentives for emerging segments like green bonds are also on their wish list.

Impact Shorts

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• Unified Tax Code: Streamlining tax policies for bonds and debt instruments could make these investments more accessible and appealing.

• ESG bond incentives: Promoting sustainable investments through tax deductions on green bonds aligns with global sustainability trends.

Various sectors of the economy: The stakeholders are seeking:

• GST Reductions: Lower Goods and Services Tax (GST) rates on essential items to boost consumer demand.

• Support for MSMEs: Incentives and policies that strengthen Micro, Small, and Medium Enterprises (MSMEs).

• Sustainability Initiatives: Encouragement of sustainable practices through fiscal measures to align with global environmental standards.

These diverse demands reflect a collective aspiration for a balanced and forward-looking budget that addresses immediate economic concerns while laying the groundwork for sustainable and inclusive growth.

Key budget proposals: What’s on the table?

Rationalisation of tax on debt instruments

India’s tax structure has long favored equities, often to the detriment of debt instruments. Potential reforms could address this imbalance:

• Restoration of indexation benefits: Reintroducing indexation for debt mutual funds held over three years would make them competitive with other investment options.

• Reduction in TDS: Lowering the tax deducted at source on bond interest could enhance liquidity for retail and institutional investors.

Changes in LTCG and STCG Rates

Speculation surrounds potential revisions to long-term and short-term capital gains tax rates, aiming for simplicity and alignment across asset classes.

• Equalized Capital Gains Tax: Equalized effective tax rates or equalizing the holding period for qualifying under LTCG, for equities and bonds could encourage a balanced approach to portfolio diversification.

• Lowered Rates: Reducing LTCG and STCG rates on bonds, or restoring indexation benefit on bonds might make them more appealing to risk-averse investors.

Introduction of tax-free bonds

The reintroduction of tax-free infrastructure bonds could create a win-win scenario for investors and the economy.

• Long-Term Capital Formation: Tax-free bonds could mobilize funds for critical infrastructure projects while offering attractive returns.

• Increased Retail Participation: The tax-free nature of these bonds would make them a preferred choice for individual investors.

ESG and green bonds

The rising importance of sustainability may drive targeted incentives for green bonds.

• Tax breaks on green investments: Deductions for investments in ESG bonds could accelerate capital flows into environmentally focused projects.

• Government backing: Providing guarantees or partial risk cover for green bonds could attract private sector participation.

Introduction of inflation-linked bonds

Inflation-linked bonds (ILBs) could serve as a hedge against inflation while ensuring stable real returns. Their introduction could benefit both investors and the broader market.

• Stable real returns: ILBs could protect investors from inflationary pressures, making them particularly attractive during high-inflation periods.

• Market depth: These bonds could add diversity to India’s fixed-income segment, attracting a broader investor base.

Ease of Doing Business and Financial Reforms

Reforms aimed at improving India’s business environment and positioning it as a global financial hub would significantly impact the bond market:

• Simplified Regulatory Approvals: Streamlined compliance processes could encourage bond issuance by reducing red tape for companies.

• Support for GIFT City: Tax incentives and a strong regulatory framework for Gujarat International Finance Tec-City (GIFT City) could attract global financial players and promote international bond transactions.

• Enhanced Transparency: Clear and consistent governance frameworks could instill greater trust in corporate bonds among both domestic and international investors.

Macroeconomic context and fiscal discipline

The bond market is deeply influenced by fiscal and economic priorities. As India aims to balance growth with fiscal prudence, the following factors are likely to play a crucial role:

• Fiscal deficit management: A clear roadmap to reduce the fiscal deficit while maintaining growth momentum could stabilize interest rates and enhance investor confidence.

• Borrowing olans: The government’s reliance on market borrowings through G-Secs could have a ripple effect on corporate bond yields and liquidity.

• Inflation control: Policies that complement monetary measures to control inflation could safeguard bond returns and maintain investor trust.

What it means for you as a bond investor

For bond investors, the potential reforms hold promise:

• Diverse opportunities: Tax-free bonds, green bonds, and inflation-linked bonds could offer varied and appealing investment options, catering to different risk appetites and objectives.

• Better returns: Rationalised taxation and stable macroeconomic policies could improve returns on bond investments, making them a compelling alternative to other asset classes.

• Enhanced market liquidity and depth: A more vibrant bond market with robust liquidity could provide greater ease in trading and diversification, enabling retail investors to participate more actively.

Conclusion: Will Budget 2025 be a game-changer?

Budget 2025 could be a watershed moment for India’s bond market. Industry insiders believe that with targeted tax reforms and structural overhauls, the government has a golden opportunity to position the bond market as a dynamic engine of growth for the economy. A focus on fostering technological innovation and aligning policies with international best practices could further bolster investor confidence. Rationalizing tax treatment for debt instruments, reintroducing tax-free bonds, introducing inflation linked bonds, and fostering retail participation could transform the market landscape. Additionally, the focus on ESG and green bonds aligns with global trends and India’s sustainability goals.

While expectations are high, the actual proposals will determine the extent of their impact. If implemented thoughtfully, these measures could position the bond market as a robust pillar of India’s financial ecosystem, driving growth, stability, and inclusivity in the years to come.

The author is Co-founder, Jiraaf. Views expressed in the above piece are personal and solely those of the author. They do not necessarily reflect Firstpost’s views.