Shashank Savla

Will India’s corporate tax cuts reignite investment?

Shashank Savla

India

In a surprise move, India’s finance minister Nirmala Sitharaman has announced significant tax cuts in an effort to combat the country’s economic slowdown and to kick-start investment. She cut the effective tax rate for corporates to 25.2% from 34.3%. It was also announced that new manufacturing firms registered after October 2019 will have an effective tax rate of 17% provided production commences before March 2023.

 

This brings India’s corporate tax rate broadly in line with the 17-25% charged by Southeast Asian countries. This could attract firms planning to shift manufacturing facilities out of China amidst the ongoing US-China trade war, in addition to incentivising domestic companies to bring forward capital expenditure plans.

 

The tax cuts mean that the Indian government has sacrificed fiscal prudency to boost growth in the near term. Along with other measures, the tax cuts are expected to result in a revenue loss of INR1.5 trillion and increase the central government’s fiscal deficit to 3.7% from the current year’s original target of 3.3%.

 

Following the slowdown in India’s growth – 5.0% in the second quarter of 2019 compared to 8.1% at the beginning of 2018 – some stimulus measures were expected. The size of the tax cut took markets by surprise, however. The Nifty Index rose by slightly more than 5% after the announcement, roughly matching the 6-10% increase in earnings that analysts expect from the tax cuts.

 

The key question is whether the tax cuts potentially reignite an investment cycle, which would be positive over the medium term. More needs to be done for this to materialise, especially in terms of infrastructure spending. Another limiting factor is the country’s rigid labour laws – a politically sensitive subject – which hinders setting up large labour-intensive manufacturing facilities.

 

While significant labour reforms seem difficult in the near term, many other changes have been implemented. India’s ranking in terms of ease of doing business has been improving and the government has also opened up more sectors for foreign direct investment. We have been positive about the reforms initiated by PM Narendra Modi since his election in 2014 and the strong mandate given to him when he was re-elected this year should enable him to continue pushing through needed reforms.

 

While we are constructive on the medium-term outlook for growth for India, valuations are still expensive at almost 17 times forward price/earnings, a significant premium to the Asia Pacific ex Japan market, which is trading at 13.5 times. The sectors that should benefit most from the tax cuts and a pick-up in capex are banks and industrials. However, we believe it will take time for the full benefits to materialise, so we are reluctant to chase the recent strong performance. We continue to follow developments closely and look for opportunities that will provide us with the combination of attractive valuations, earnings growth and dividend yield.

 

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The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing. Article content goes here

Friday, October 4, 2019, 11:45 AM