The current economic scenario does not augur well for global outlook, and this is one of the reasons for why over the past months many market participants were vocal in pushing the fiscal expansion ideology.
Selective emerging market economies hold the capacity for fiscal expansion with the latest being India which proposed a corporate tax cut, from 30% to 22% for domestic companies.
The significant reduction in corporate tax rate sends a strong signal to investors that the Indian government recognizes the need to improve India's economic growth and boost the corporate sector's competitiveness.
This fiscal change comes at a time when India's annualised gross domestic product (GDP) growth is slowing. Markets saw India’s GDP grow by just 5% in the second quarter of 2019, marking the fifth consecutive quarter of declining growth. In fact, India's growth fell behind that of China, which grew 6% in the second quarter.
In the instant aftermath of the tax announcement, India's equity market reacted positively to the news, while the Indian rupee rallied. However, bond markets declined on fears that the Indian government may now have to borrow more to meet the additional expenditure.
Refining India's competitiveness
It is expected that corporate tax cuts should likely help boost capital expenditure and attract foreign investments to India. India's corporate tax rate is now on par with its regional peers that have manufacturing hubs, such as Cambodia, Taiwan, Thailand and Vietnam. In addition to, India's corporate tax rate is now more competitive than China's 25% rate.
New, lower corporate tax rates also included new manufacturing companies. Businesses that start operations between October 2019 and March 2023 should be eligible to apply for a 15% corporate income tax rate. This ties in with the "Make in India" initiative
"Make in India" scheme to act as a global manufacturer
The government's "Make in India" program, intended to turn India into a global manufacturing hub, is gradually gaining ground and should likely benefit a variety of sectors, namely the electronics manufacturing sector.
As an example, Samsung opened the world's largest phone factory near New Delhi earlier last year, in order to manufacture phones at low costs and improve competitiveness in India's huge smartphone market. In the long term, one could see a substantial rise in the share of locally manufactured products, which would also portend well for India's current account balance.
Sector Implications
Levels of impact will differ from sector to sector, particularly those subject to the highest effective tax rates.
At a company level, a reduction in the tax rate will likely boost cash holdings and increase corporate profitability. This could maybe even lead company management to repay debt, pass on cost savings to consumers through lower pricing, or distribute dividends to shareholders through share buybacks.
For cash-rich companies, another potential consideration might be to resume capital expenditure. This spending could likely bring a positive multiplier effect on the broader economy in the medium to long term.
Broadly speaking, the global industrial universe has spare capacity and is staring at a demand slowdown. That said, India has the potential to become a supportable alternative for companies wanting to diversify manufacturing processes away from China.
For the financial industry, some of the benefits of a lower tax rate might eventually be passed on to consumers in the medium term. Banks with alternative business segments, such as personal loans and credit cards, could stand to gain the most from the tax adjustment.
As long-term investors, India's corporate tax cuts should help incentivise investment. As India copes with slowing GDP growth, the Indian government has taken steps to give companies an enhancement to draw investors and restore confidence in the country's dynamic economy.
Disclaimer: This article was issued by Maria Fenech, Credit Analyst at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.