Market Report

India strategy – The big deal

by Mahesh Nandurkar / Sep 23, 2019

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The Modi government has signalled a change of stance from tight fiscal policy and populism to pro-growth with US$20bn in stimulus. But a consistency can be seen in an ‘investment-driven’ growth push rather than a direct ‘consumption push’. Simplistic assumptions of a lower corporate tax rate imply a 7-8% EPS upgrade for the Nifty, but the actual EPS impact may be lower. While this move may not drive up capex or consumption immediately, it is a rerating event as the hopes of an economic revival improve. This bold step also raises hopes of strategic PSU disinvestment.

Among the boldest reforms
At the Independence Day speech on 15 August 2019, Modi had said that ‘wealth creators deserve respect’. The landmark corporate tax cut translates that thought into reality. The cut puts India on par with Asian counterparts on corporate tax rates, and is now among the lowest tax jurisdiction for new manufacturing companies. More importantly, it shows that this is a government that listens and can take bold steps to revive the economy. The hopes of more government action will remain.

Economic priorities clarified
With this Rs1.45tn package, and a few small steps announced earlier, the government’s pro-growth priorities have been established. Media reports indicate that more growth measures maybe in the offing. The GST council reduced the GST rate for hotels but did not cut rates in industries like autos and cement. This reinforces the government’s preference for an investment-driven upcycle.

Negative fiscal impact but growth support overcomes that concern
The corporate tax cut will cost Rs1.45tn (c.19% of budgeted) or c.70bps of GDP. The centre’s shortfall is c.40bps (60:40 sharing with states). This, coupled with weak tax collections imply a fiscal deficit for the central government of about 4% of GDP as likely. Though credit negative, we see limited threat to the RBI’s rate-cut cycle as of now. Low inflation (3.2%) implies headroom for rate-cuts is high (c.75-100bps). Improved outlook for FDI inflows, also tax cut on debt LTCG/STCG should augur well for capital inflows and the rupee should remain largely stable. A comparative analysis of the impact of large corporate income-tax cuts taken elsewhere in the world shows that the subsequent two years show an average 2.2ppt increase in GFCF ratios and a 0.7ppt increase in GDP growth rate.

Market factors in earnings upgrade potential but not sentiment turnaround
The impact of corporate tax cuts is an improvement in the capex outlook. Part of the new capex should come via FDI wherein the trade-war relocations provide an immediate opportunity. Consumption improvement is a secondary impact as it may not be immediate and would be subject to corporations passing on the tax cut.

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