Since July 6, 2019, when Finance Minister Nirmala Sitharaman presented India with a Budget that she said, was ideated with a 10-year vision in mind, Indian economy has been through many shifts.
On September 2, 2019, Bloomberg reported that economists have cut their forecasts for India’s economic growth and predicted deeper interest-rate cuts after data showed a sharper-than-expected slump in output.
Goldman Sachs Group Inc. and Citigroup Inc also lowered their growth projections to 6% for the fiscal year through March 2020, while Oxford Economics Ltd. said there’s a risk the expansion could be weaker than that.
According to Bloomberg, data indicated that the weakness was broad-based, with consumption and export growth slowing while investment remained subdued. And that the slump will put the onus on the Reserve Bank of India (RBI) to continue cutting interest rates after 110 basis points of easing already this year.
In this Moneycontrol Deep Dive, we will examine how the government which is sticking to its 7% growth projection for the fiscal year is dealing with this unfolding situation. Recent steps to improve India’s longer-term growth have aimed at merging state-run banks to help spur credit growth, easing foreign investment rules and giving concessions on vehicle purchases. But the biggest surprise has been a corporate tax bonanza and we will get to that in a bit.
Decelerated growth rate and beyond
As various reports have been stating, India's economic growth has been the slowest in more than 6 years at 5% in the June quarter of 2019-20.
In August, the Finance Minister announced many new provisions to address the issues supposedly slowing down the economy including rollback of enhanced surcharge on foreign portfolio investors levied in the original Budget. This was done supposedly to encourage investment in the capital market. Also mooted was the withdrawal of angel tax provisions for startups and their investors, capital infusion of ₹70,000 crore into public sector banks to generate an additional lending and liquidity in the financial system to the tune of ₹5 lakh crore.
Additionally, loans for home, vehicles and consumption goods became cheaper and are to be made widely available through banking and non-banking finance companies. Among other measures, working capital loans for industry were also to become cheaper.
At a recent press conference, Finance Minister Nirmala Sitharaman referred to these measures and we quote: "The government has been in consultation with a lot of sectors. Because in some sectors, the inventory is piling up... different issues for different sectors and having heard that and having spent some time to see how best we can respond, the first tranche of announcement were made on 23 August.” Unquote.
The biggest ever tax reduction
On September 24, 2019, Press Trust of India (PTI) reported how the government on September 20 announced the biggest reduction in 28 years in corporate tax rate by almost 10 percentage points in an effort to pull the economy out of a six-year low growth. The measure is also aimed at addressing a 45-year high unemployment rate by reviving private investments with a Rs 1.45-lakh crore tax break.
This week, RBI Governor Shaktikanta Das described the government's move to slash corporate tax rate as a bold measure and said that it has made India a very attractive destination for foreign investment.
The give a context, PTI explained that corporate tax for existing companies has been reduced to 22 per cent from the current 30 per cent; and for new manufacturing firms, incorporated after October 1, 2019 and starting operations before March 31, 2023; it was slashed to 15 per cent from the current 25 per cent.
Shaktikanta Das said and we quote, "So far as international investors are concerned, so far as FDI is concerned, I think India stands definitely in a very competitive position, and would be able to attract higher investments." Unquote. He added that domestic investors, will now have more cash so they'll be able to undertake more capital expenditure.They can invest more and some of them can deleverage their liabilities which will add strength to their balance sheets, he said after meeting Finance Minister Nirmala Sitharaman.
Another three-day monetary policy committee meeting will begin on October 1 amid expectations of another rate cut to be announced on October 4 in a bid to revive the sagging economy, PTI reported. The RBI, as we mentioned at the beginning of the podcast, has already cut rates four times to the tune of 110 basis points this year to push growth.
However PTI added that Das has refused to share RBI's revised growth projection, stating that it will go public with the revised numbers at the upcoming monetary policy announcement on October 4.
Economists analyse corporate rate reduction
News agencies have since 20 September published various takes on the reduction in the base corporate tax rate to 22% from 30% as part of stimulus measures to revive the slowing economic growth.
On Saturday, global rating agency Moody's said that corporate tax reduction is credit positive for companies because it will enable them to generate higher post-tax incomes companies but the step will increase the government's fiscal risks.
Moody's said and we quote, "As such, the reduction in corporate income tax revenue —even when balanced against the windfall from the recent transfer of central bank surplus reserves, equivalent to around 0.3% of the GDP in the current fiscal year - further narrows fiscal room for manoeuvre. This assumes that the government does not cut expenditure to offset the revenue loss.” Unquote.
You will remember that in August, The Reserve Bank of India (RBI) agreed to reportedly transfer ₹1.76 trillion to the government this fiscal. The transfer includes ₹1.23 trillion of surplus for 2018-19 and ₹52,637 crore of excess provisions identified as per the revised Economic Capital Framework (ECF).
Still Moody's pointed out that while the tax reduction brings India's corporate tax rate closer to peers throughout Asia and will support the business environment and competitiveness, a host of cyclical factors, including rural financial stress, weak corporate sentiment, and a slow flow of credit in the financial sector, remain headwinds to near-term growth.
On September 24, 2019, CNBC cited economists to opine that a cloud of questions hovers above the real impact of an unexpected tax cut announced by the Indian government. The primary concern has been just how the tax cut will make up for the lost revenue.
According to CNBC, the government reportedly has estimated that the lost tax revenue would be 1.45 trillion Indian rupees (about $20.45 billion) — about 0.7% of India’s GDP.
CNBC cited Vishnu Varathan, head of economics and strategy at Mizuho Bank who said that the figures released by the Indian finance ministry are very fair in conceding that a gap exists as far as loss of revenue is concerned. He added though that the elephant in the room was the question surrounding where the ongoing offset for this loss in tax revenue will come from. He repeated and we quote, "That’s the question left unanswered in the entire announcement about tax cuts.” Unquote.
However David Mann of Standard Chartered has stated that the moves by the Indian government could work. Mann, global chief economist at Standard Chartered Bank, told CNBC this week and we quote,"If they get growth stronger, and if they can broaden the tax base and actually improve the amount of the economy that they actually do receive tax from, this could be a positive thing." Unquote.
Amy Kazmin wrote in Financial Times this week that though India’s unexpected $20bn corporate tax cut, unveiled last week, has triggered euphoria among business chiefs and equity investors, economists continue to be concerned about the lack of purchasing power among Indian households and the recent chosen fiscal stimulus method, which will cost the government about 0.7 per cent of GDP each year. And it will not swiftly strengthen consumer demand, warns the piece.
The article emphasises and we quote, "The real problem facing India is not that it is too expensive to do business but the fact that there is no demand." Unquote. The piece also cites Jahangir Aziz, head of emerging markets research at JPMorgan who said that this is classic trickle-down economics and that though nobody is doubting that the economy needed a boost, or policy support, still if you go down the list of choices the government could have made, giving a corporate tax cut now wouldn’t have been in the top five.
According to him, cutting goods-and-services taxes, which would reduce prices, would be a more effective way to boost consumer demand while other economists say a cut in personal income tax would have had a wider impact.
Aziz added, “If you want to boost consumption, you reduce the price of things people are buying.” Unquote. He also expressed the fear to The Financial Times that the rising consolidated public sector deficit — already at about 9.5 per cent of GDP before the tax cuts — will drive up the cost of capital and threatens to crowd out the private investment New Delhi is so eager to encourage. We quote him, “With these kind of numbers, it’s very hard to see how investment can increase without corporates going abroad and borrowing, which means the current account deficit will go up." Unquote.
According to the piece, the corporate tax cuts are expected to yield dividends in the longer-term, helping woo job-generating foreign direct investment as US-China trade tensions rise. But as the writer warns, any boost will come at a cost, putting pressure on India’s public finances in the absence of other big reforms — such as large-scale state disinvestment — to curb the fiscal deficit and check volatility.
The Financial Times also cites Ritika Mankar, senior economist at Ambit Capital who also repeats that though the boost to the manufacturing sector is undeniable, it means that India’s fiscal risks will rise to the fore. Author Gurcharan Das, also the former chief executive of Procter & Gamble, told The Financial Times more optimistically that there is never a wrong time to do the right thing and the measures will make India competitive. He said and we quote, "If we want to get investment from those leaving China, we need tax rates that are competitive with those in Vietnam, Bangladesh, Indonesia and other countries to which they are moving.” Unquote.
What if India’s corporates don’t invest?
Rahul Menon wrote in qz.com on September 23, 2019 that though India’s sagging economic growth has finally forced the government to relax its strict fiscal deficit targets, even that may not guarantee a recovery.
The piece cites the September 20 announcement made by Finance Minister Nirmala Sitharaman regarding a stunning reduction in the country’s effective corporate tax rate from around 35% to 25% and reiterated like many other sources that though India’s equity markets cheered the decision, the bond markets tanked on fears that the government may now have to borrow more to meet its expenses.
The piece underlines yet again that the move, which involves forgoing Rs1.45 lakh crore ($20 billion) in annual revenue, will widen the government’s fiscal deficit—the difference between revenue and expenditure—from the current target of 3.3%, to 4% of GDP this financial year.
We quote, "The rationale behind giving deficit targets a miss is that it will incentivise the private sector to invest more, as companies can now expect higher profits. This will eventually lead to, it is hoped, an economic revival. Yet, there are serious caveats in this reasoning.
While rigid fiscal deficit targets can be constraining, as it forces the government to cap expenditure and squeeze out more tax from companies, an increase in fiscal deficit does not necessarily entail growth. Given the nature of the current slowdown, which is mainly due to weak consumer demand, there is no reason to imagine that private companies will invest more if their tax outgo decreases. If consumers are not spending in the first place due to high unemployment and diminishing wages, then additional investments become risky.
There may not be many avenues for companies to invest anyway. For instance, why would lower corporate tax rates encourage auto companies to ramp up production, given placid demand?" Unquote.
A more effective solution on the government’s part, says the writer, is to increase consumers’ disposable incomes by a direct injection of investment, instead of maximising private sector profits. Such a stimulus can also create new investment opportunities for the private sector by raising consumer demand, he writes.
In a country where economic inequality is ever increasing, the current corporate tax rate cuts, says the writer, are more likely to impact the distribution of income than growth or employment. We quote, "Companies will now get a larger share of profits from existing investments, while the economy remains on the slow lane. There is a very real danger that this would exacerbate inequality. All this, is deeply worrying." Unquote.
Will Trump-style tax cuts fix the economy?
Wall Street Journal's Mike Bird doesn't think so. In a report this week, he says what we have been hearing from various observers that corporate tax cuts are good news for the equity market, but don’t address the issues that have left India with its slowest growth in years.
But he begins the piece by addressing a fundamental issue. We quote, "India taxes companies far too highly. At 48.3%, its total corporate income-tax rate was the highest among 74 countries ranked by the Organization for Economic Cooperation and Development in 2018.
The Indian government has proposed reducing the headline corporate tax rate to 22% from 30%, effective from the start of the current tax year in April. The cut is likely to boost the earnings growth of companies in the MSCI India index by around 6 percentage points this calendar year and next, according to Goldman Sachs analysts. The sectors that will benefit the most are raw materials, financials and industrials, which currently have the highest effective tax rates.
Foreign funds have pared down their holdings of Indian shares since 2014-15, when a burst of optimism about reform drove portfolio managers into the country’s stock market. The tax cut provides an opportunity for them to rebuild their allocations, but caution is warranted." Unquote.
Indian stocks, he reminds the readers, aren’t cheap. Even before rising around 8% on Friday and Monday, the country’s equities fetched more than 18 times expected earnings over the next year, expensive by historical standards, he states.
But the upside for the broader economy is more limited than it is for corporate earnings, says the piece and reminds us once again that growth slipped to just 5% in the last quarter compared with a year earlier, the lowest of this government’s tenure.
We go over all the points made by the writer, "The country’s expansion has been squeezed by a successful crackdown on nonbank financing and an uncomfortably large pile of bad debts.
Attempts to make land easier to acquire, and staff to hire and fire, have proved unpopular and hit roadblocks. The implementation of a nationwide Goods and Services Tax to replace a web of varied state-level charges was beset by glitches. Amid such problems, the government seems to have lost what zeal it had for the kind of big-ticket reforms needed to unlock India’s growth potential in the longer term. The finance ministry last week asked banks not to designate loans to micro- to medium-size businesses as nonperforming assets, even when they have been in arrears for 90 days, until March 2020. The country’s nonperforming loan ratio has dipped from its 2018 high of almost 11%, but at around 9%, it remains too high for comfort. Banks were also asked to organize loan melas—public gatherings between customers and banks to encourage more lending.
There is no point in India cracking down on shadow banking only to encourage regular banks to rack up problem loans." Unquote.
The point being that without addressing core issues, sweeping reforms will grab headlines but bring about little grass root or long term change.
As the writer says, "Investors should enjoy the tax cut. But without fresh reform impetus, and paired with some uncomfortable signs of backpedaling on private-sector debt, it won’t shift the needle very far when it comes to India’s growth trajectory."