Rajiv Gandhi Equity Scheme is too much pain with little gain

By R Jagannathan

In his anxiety to keep the markets in a state of good cheer so that he can unload lots of public sector equity, Finance Minister P Chidambaram has okayed a dubious equity scheme for first-time stock investors that makes very little sense.

That it is being made in the name of Rajiv Gandhi - it is called the Rajiv Gandhi Equity Savings Scheme (RGESS) - may not go down well with Madam Sonia if the scheme is a resounding flop.

For a scheme (read the details here) that is supposed to encourage new retail investors who have never invested in stocks to finally take the plunge, it should have been a simple one that is easy to understand. But RGESS is anything but that_._

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The main attraction of the scheme, announced by Pranab Mukherjee in his last budget, is that it offers investors a 50 percent deduction for investments upto Rs 50,000 under a new Section 80CCG (which will save you Rs 5,000 in the 20 percent tax bracket). The eligibility limit is upto Rs 10 lakh of taxable income. But it’s not easy to navigate the scheme.

Consider how it is supposed to work.

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First, you need to have an income-tax PAN and a depository account. Which is fine, since this is the only way the taxman can find out if you already own shares. But the scheme also says you shouldn’t have dabbled in derivatives - wonder how they will find that out, especially if you have done it through a broker on the sly.

Second, the choice of stocks is limited. You can invest in “stocks listed under the BSE 100 or CNX 100, or those of public sector undertakings which are Navratnas, Maharatnas and Miniratnas” or their followon offers. Since losers like MTNL are labelled as Navratnas, the list does not automatically guide first-timers to profitable companies. How a newbie investor is supposed to find the right stock so that he does not make a mistake nobody knows. If he burns his fingers, RGESS will turn him off stocks for good.

Third, some mutual funds and exchange-traded funds (ETFs) investing in these kinds of shares are also eligible for investment. But you have to buy these funds or ETFs from the stock market through a depository account. There’s no escaping that.

Fourth, and this is the biggest put-off, the scheme specifies a three-year lock-in, that is essentially a more complicated one-year lock-in. You can sell your share/shares after one year, but you have to reinvest the initial amount (for which you claimed a tax deduction) back by buying from the same select list of shares.

But this is where further complications set in.

If, say, you bought shares worth Rs 50,000 and next year you sold it for Rs 25,000 ( a loss of Rs 25,000) you have to invest only Rs 25,000. That is, even after a loss, you are invited to put more money in stocks with what you have managed to salvage by cashing out. If you made a profit (say, if you sold it for Rs 60,000), you have to invest only Rs 50,000. You can’t put the whole amount in your bank FD.

And it gets worse. You have to maintain the initial value of the investment (Rs 50,000 in our example) for at least 270 days in years two and three.

Another complication is that you can invest Rs 50,000 in several bits and pieces, but this is not advised, since the trauma of keeping track of lock-in dates for so many separate dates of investment can drive you nuts. All for a tax-saving of Rs 5,000 max.

The Rajiv Gandhi Equity Savings Scheme is simply badly designed and does not really qualify as a welcome mat for new retail investors seeking to channel their hard-earned money into stocks.

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) to the markets so that they benefit from any long-term upside.

The Department of Revenue and market watchdog Sebi are expected to notify RGESS in the next two weeks.

We recommend that they should sleep over it a little longer and come up with a more investor-friendly version. Unless they want to resounding flop on their hands (read here ).