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Tax tweaks may re-route deposits from mutual funds
March, 03rd 2007

Likely to trim lucrative returns offered by money market MFs

With banks still battling to raise resources, the Finance Minister's tweaks to dividend distribution tax (DDT) have come as succour from North Block.

Bankers said that the hike in DDT would help reverse the disintermediation of bank deposits to money market mutual funds. Mr P. Chidambaram had raised the DDT to 25 per cent from 12.5 per cent for retail investors and to 25 per cent from 20 per cent for corporates.

Slack accretions

Bank deposits have grown by 23 per cent on a year-on-year basis, as against a loan portfolio growth of close to 29 per cent. Despite all out efforts, banks' attempts to increase the pace of deposit accretion are yet to bear results. Even after pushing deposit rates close to 7.5 per cent for one, accretions have remained slack.

With the equity and money market funds offering higher returns on investments, both retail and corporate depositors had exited bank deposits to these avenues. On the other hand, the outstanding on money market funds was Rs 1,35,523 crore in January end this year or an 81 per cent growth over the corresponding period the previous year. Bulk depositors, especially corporates and insurers with short-term cash surpluses, have preferred money market mutual funds (MMMFs).

Banks' only trump card was liquidity, though even this stood blunted, since MMMFs also offered high liquidity, through periodic repurchases. In fact even after some correction in tax distortions last year between instruments, things have contributed little to reverse disintermediation.

Last year for instance the Budget had allowed for benefits under 80 cc for bank deposits. This allowed depositors for five years and above the same tax concessions as in the case of other long-term instruments. However, this time bankers expect it to be different.

Reactions

The Vijaya Bank Chairman and Managing Director, Mr Prakash Mallya, says,

"We can now see a reversal in disintermediation after the tax tweak by the Finance Minister." This is because the hike in DDT would shave off some of the lucrative returns that MMMFs have now been offering to retail and corporate depositors.

Some bankers though have preferred to remain circumspect on the impact. The ING Vysya Bank economist, Mr Harish Menon, says, "MMMFs have had little impact on flows into bulk deposits. But changes in the DDT are unlikely to lead to any large flows into term deposit accounts from retail depositors since the rate differential will still favour the MMMFs."

Yet despite this caution, some corporates have begun taking a look at switching portfolios from MMMFs. This is especially since banks are offering rates of up to 10 per cent for 18-month deposits and in the case of certificate of deposits (CDs) for one-year tenor, the rates were higher.

As a result, accretions into CDs have accelerated for the fortnight ended January 19, the latest period for which data is available. The outstanding CDs were Rs 2,000 crore, most of them yielding close to 10 per cent. This trend is now expected to see acceleration from April when the budget proposals take effect, bankers said.

C. Shivkumar

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