The lowering of corporate taxes is one of the biggest structural reforms by the government and will not only boost economic growth, but also incentivise investments and push employment. There is a chain reaction that comes out of such moves, Ajay Menon, MD & CEO, Broking & Distribution at MOFSL, said in an exclusive interview to Moneycontrol's Kshitij Anand.
Edited excerpts:
Q: A big short in the arm for corporate India. Some are even saying that it is the biggest reform since 1991. What are your views on the government’s decision to slash tax rates?
A: After a series of baby steps to boost growth over the past month, the Indian government took a giant leap on September 20 by unveiling a big-bang fiscal stimulus in the form of a sharp reduction in the corporate tax rate from 30 percent to 22 percent and a fillip for investments in manufacturing. At $20 billion impact, the cut in tax rates provides a sizable boost to the animal spirits of corporate India, with potential to drive investment, sentiment and in turn consumption.
Last time the corporate tax rates were cut by such a magnitude was in the famous 'Dream Budget' of 1997. With this step, the government has done its part for the time being, in our view. Now the ball is in the court of corporate, as to how they utilise this stimulus to drive investments and consumption.
Q: Can we say that government has given a Diwali gift to corporates well in advance and reversed the bearish trend in the market?
A: The government's clear focus on reviving growth is a big sentiment positive for equities. The tax cuts provide a decent boost to earnings (22 percent CAGR for Nifty EPS over FY19-21E) in an otherwise tepid earnings delivery over the last three years.
Over medium term, it has the potential to kick-start the investment cycle, even as banking asset quality continues to improve gradually. Benign monetary policy and surplus monsoon are the other key positives. Valuations at around 19x FY20, though not cheap, can overshoot over the near term, in our view.
Q: If the momentum continues, can we hit a fresh record high by Budget 2020?
A: We believe that this is one of the biggest structural reforms from the current government and will not only boost economic growth, but also incentivise investments and push employment. There is a chain reaction that comes out of such moves.
The market is cheering the prospects of enhanced EPS, but the chain effect will be way bigger and hence we expect market to see a significant upmove from here due to i) increase in EPS ii) rerating due to higher growth and improved investment environment. Hence, we expect the current momentum in the market to continue.
Q: What is the fine print on the buyback tax on listed companies? Do you think it will lead to more buyback offers?
A: The government has provided relief for companies which announced buyback before July 5 (grandfathering) when the new 20 percent tax on buyback was introduced by the government in the budget. Enhanced surcharge on buyback of listed shares announced before July 5 (pre-budget) is waived. However, buyback announced after July 5 shall continue to be applicable for buyback tax at the rate of 20 percent. This, however, will be taxable in the hands of the shareholders. Hence, the relief is limited to buybacks announced earlier and as such, may not lead to more buybacks in future.
Q: Which companies or stocks are likely to benefit the most from the corporate tax cut?
A: If we keep all other things the same, the reduction in the corporate tax rates should result in around 8 percent upgrade in the Nifty EPS for FY20/21. Private banks, auto and consumers will be some of the biggest beneficiaries, while IT will not see any incremental positives from these announcements. The exact quantum of benefits will be a function of how a company decides to utilise the benefits from the lower tax rates.
Deleveraging of balance sheet, price cuts/higher promotions to consumers, higher payouts to shareholders via dividends and higher capex investments are some of the options available to capital allocators. How an individual company apportions the benefits will decide the course of corporate earnings over the near term.
Q: What are your views on the government which has been proactive on every front to boost the economy and put India back on the $5-trillion economy mark?
A: These announcements clearly signal the government's shift from 'fiscal prudence' to 'growth revival'. Monetary policy has already been supportive with substantial rate cuts since February 2019. Now, the big fiscal stimulus will provide a major push for growth. The measures announced are substantive and have the potential to kick-start the declining investment cycle over a period of time.
A probable rise in the corporate savings rate after the latest announcement augurs well for private capex cycle. The sentiment boost provided by these measures, coupled with the transmission of the 110bps of rate cuts already done by the RBI, can also at the margin provide a push to consumption in the midst of an all-important festive season. The significant recovery in monsoon should also aid rural consumption, albeit with a lag.
Q: Do you think FII flows will reverse following the announcements?
A: FIIs have been big sellers in this quarter, with net outflows of $5 billion, while domestic funds have remained buyers during the period. We expect the FII flow to respond positively to these measures and grow as economic activity gets better.
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