The government announced sharp cuts in corporate taxes worth Rs 1,45,000 crore. The idea is that companies would use the money for expansion. They would hire more people and trigger a positive economic cycle. There is an expectation of more businesses registering themselves in India or setting up new manufacturing units to take advantage of lower taxes than before.
Less is more, is the new mantra. While these tax reforms do not directly affect your loans or personal income, they do influence your investments.
Indian companies are in a sweet spot. The consumer price inflation is hovering around 3 per cent. It allows the Reserve Bank of India to keep borrowing rates low. With the cut in corporate tax rates, businesses have more money in their hands. That is good news for the shareholders of these companies.
Now, companies will have to use these resources. They would either retire debt or use it for setting up new factories. They may reward themselves or their shareholders or employees with more cash payouts through dividends or bonuses.
If the wealthy businesspersons pay themselves, the government has already raised taxes for them. There is a good chance that they may use the money to give it back to the banks for clearing old debt. They may also pay employees to retain or hire quality talent.
It is an expectation that the money would find the right way to channelise itself and stimulate economic growth.
The stock market reaction to such announcements is usually euphoric in the beginning. Today’s stock prices are a reflection of tomorrow’s profits. By the time we reach the end of the financial year in March 2020, companies would get the upside of 7-10 per cent in earnings per share (EPS), according to most market analysts.
For the quarter to June 2019, average profit growth represented by the EPS growth was 6-7 per cent, a sharp fall from 18-19 per cent in the year-ago period, according to CARE Ratings, a rating agency.
Stock markets have witnessed a selloff by foreign portfolio investors. Investors have shown a low appetite for equity assets.
The BSE Sensex and the NSE Nifty barely moved in 2019. Those investing in equities can continue with the monthly systematic investments. There is no need to suddenly jump and allocate all your surplus money to equity markets. Start a new Systematic Investment Plan (SIP) if you have not done it yet. Like we said earlier, less is more.
For those investing directly in equities, banks and non-banking finance companies are being suggested by most brokers as likely beneficiaries of these tax reforms. The profit growth is expected to be much higher as a result of a lesser tax than before.
The other sector to benefit would be the consumer sector. Average profit growth is expected to get a boost by 10-14 per cent. The hope here is that companies would offer better deals to consumers to boost sales. It means they would pass on the tax benefits to consumers who would then spend more.
India’s economy majorly being consumption growth-led, thus assumes significance.
The automobile sector has witnessed a significant slump in 2019. The BSE Auto index saw an 18 per cent fall in 2019 so far. However, that includes the 10 per cent jump in the index value last Friday. It goes to show the extent to which investors expect the automobile sector to benefit.
But many are throwing caution to the wind. Tax cuts are unlikely to boost consumer demand. India’s economy is witnessing structural issues.
R C Bhargava, chairman, Maruti Suzuki India, was quoted as saying that millennials prefer gadgets over cars. If that is the case, then the automobile sector demand is likely to witness a structural slowdown.
The other word of caution is about government finances. The 10-year government bond prices jumped sharply last Friday.
It is a benchmark for the risk associated with a country. In rich countries, bond prices hover near 1-2 per cent per annum. In India, they carry an interest rate of 6.8 per cent. It means investors expect government finances to be weaker with a higher deficit and increased borrowing. That generally tends to stoke inflation and makes it challenging to lower borrowing rates.
Low inflation in the economy could still allow some headroom for the Reserve Bank of India.