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MUMBAI (Reuters) - Indian shares fell on Friday after the government raised short-term capital gains tax, but analysts said the move would only have a small impact on sentiment and would encourage long-term investors.
The increase in the tax rate to 15 percent from 10 percent on an investment sold before holding for a year was proposed by Finance Minister Palaniappan Chidambaram in his budget.
The move will pinch investors looking for quick gains, such as day traders and some foreign investors.
"People will feel the pinch. Short-term impact on the market sentiment is definitely negative," said Jayesh Mehta, managing director, head of institutional client coverage and DSP Merrill Lynch.
"FIIs will definitely be affected," he said, referring to foreign institutional investors.
Other analysts said the impact would be limited for foreign investors based in tax-friendly countries.
"Foreign funds operate in some kind of tax havens so the impact would not be that much," said Jigar Shah, head of research at the Indian unit of KIM ENG Securities.
The benchmark 30-share BSE index ended down 1.4 percent at 17,578.72 in choppy trade, after falling as much as 3.2 percent at one stage.
Shah agreed with the finance minister's view that the higher tax would encourage investors to take a longer view of the market.
"It is a positive step for retail public as it help them cut their short-term trading and instead focus on long-term investments," he said.
This would also help mutual funds as investors would be discouraged from selling out, said Arindam Ghosh, chief executive of Mirae Asset Global Investment Management (India).
"It may have some kind of impact on sentiment for traders but overall I think from a mutual fund perspective it's a good step because we always encourage long-term investments," he said.
Foreign funds have flocked to Asia's third-largest economy, pumping in more than $17 billion last year and helping the stock market rise 47 percent, the fifth year of a bull run.
The benchmark index had risen nearly 73 percent in 2003, 13 percent in 2004, 42 percent in 2005 and 46.7 percent in 2006, attracting a slew of foreign funds.
Some stock market players said the capital gains tax increase was the biggest blow from the budget.
"There are no major negatives there other than the rise in short-term capital gains tax. This is a sensitive subject and will have some impact on the market sentiment," said Sejal Doshi, CEO, Finquest Securities.
Vikas Khemani, co-head of institutional equities at Edelweiss Securities said the proposal could have been avoided.
"The increase is a bit negative for the capital markets and it could have been avoided as the tax collection figures have been buoyant in the past few years from the markets."