Market Event – Corporate Tax Rate Cut

Published on Sept 21, 2019.

Key Highlights –

1. FM cuts corporate tax rate from 30% to 22%. The effective tax rate for a large cap company reduced from 34.95% to 25.17%. Almost 10% reduction in absolute terms translating into 28% lesser tax outgo.
2. Govt projects INR 1.45 trillion revenue loss for FY 20.

 Impact

1. Equities – Positive in Medium Term – Stocks are directly impacted by the move as the lower tax outgo increases Profit After Tax (PAT) for corporates. Nifty likely to see 6-7% increase in earnings for FY 20. The same is discounted by today’s market movement. Further price increases should be a result of sentiment built around a revival in the investment cycle, the same we expect will come with a lag.

2. Bonds – Negative – The yields on 10 Year government bond spiked today as much by 24 basis points to 6.88% finally to close at 6.78%. The tax revenue loss will push fiscal deficit further around 3.90% even after accounting for the RBI’s special dividend to the govt.

The Bond Market is Impacted in Following Ways –

1. The prices of bonds suffered losses and so thus Debt Fund schemes having exposure in long term government debt.
2. The higher yields will make government and corporate borrowing costlier thus will increase the interest burden.
3. The case for government overseas bond sale program gets stronger.

Economy – India has suddenly come at par with the Asian peers in terms of corporate tax. Following is comparison of how India fares against other Asian economies –

Source – KPMG, Indian Finance Ministry

India ranks high now to be considered as an alternate manufacturing hub and can attract a decent amount of foreign direct investment which can aide job creation, stable currency and lower interest rate. But this is an external factor as it depends more on the global environment.

Though the larger objective behind cutting corporate rate is to boost the private investment as corporates are now left with higher cash with them, they can invest it further given there is adequate demand or they can lower the prices to boost sluggish demand or they can eventually pay higher dividends to shareholders which will benefit only a few. How this will unfold in coming times would be interesting to see.

Conclusion – We think by adopting the route of cutting corporate taxes rather than boosting spending and consumption through a fiscal package, government has tried to immediately fix the falling stock market rather than fixing the falling economy. A full fledge revival of the economy however depends upon the revival of the investment cycle, falling demand and subdue consumption. 

Team Colvek