Finance bill 2023- Manageable impact on NBFCs

Finance bill 2023: Manageable impact on NBFCs

Amendments to the Finance Bill 2023 were passed by the government last week, with the removal of the long-term capital gains (LTCG) tax benefit from debt MFs being a major highlight. This change could impact flows into mid-to longer-duration schemes, which currently have around Rs 6 trn in AUM. Additionally, the funding of corporate bonds by debt MFs could also see some negative impact, as they currently account for around 10-11% of total corporate bond funding. While this change is expected to have a negative impact on NBFCs, it should be manageable. Bonds represent only 36% of NBFCs’ borrowings, and the exposure of debt MFs to NBFC bonds has decreased following the IL&FS crisis. Currently, debt MFs fund only around 15% of NBFC bonds. However, certain NBFCs such as Chola Investment & Finance (CIFC) and Mahindra Finance (MMFS) have higher borrowings from MFs, although this includes commercial papers as well.

As per the amendment, MFs with less than 35% invested in equities will be taxed as short term capital gains based on income tax slab levels w.e.f April 1, 2023. Indexation benefit on debt MFs will be removed. At present investments in debt MFs over 3 years is treated as long term capital gains and taxed at 20% with indexation benefits.

Inflows to mid-longer duration debt MFs could moderate as removal of taxation-related benefit of pure debt MFs reduces its attractiveness vs. FDs. Retail/HNI flows to debt MFs may see some shift to FDs, but corporates may still prefer investing in debt MFs over FDs due to better liquidity and return expectations. Preference for more liquid NCDs due to uncertainty around holding period of debt MF investors could also affect credit spreads.

Corporate bonds account for nearly 36% of NBFC/HFC borrowings, but debt MF investment in NBFC/HFCs have reduced materially. We estimate debt MFs funds 15% of NBFC/HFCs NCDs. Within our coverage, CIFC (10% of borrowings) and MMFS (8% of borrowings) have higher share of borrowings from MFs, though note this also includes investments in CPs (CIFC 6% of borrowings, MMFS c.1% of borrowings) which should not be affected by the tax norm change.