Friday’s unprecedented corporate tax rate cut is set to boost company earnings. All other things being equal, the cut from 30 percent to 22 percent would mean that companies paying taxes at the full rate should see their earnings jump by 11 percent.
Indian equities, therefore, look well-positioned in the short to intermediate term. Highly taxed companies will be early winners.
However, there are many grey areas. For example, the effective corporate tax rate of many companies may be well below the new proposed tax rate, which along with surcharge and cess works out to around 25.17 percent.
Hence, the impact of the various tax provisions will vary across sectors, sub-sectors and businesses.
Tax reduction to be beneficial across sectors
India remains a service-based economy as it contributes more than half to the country’s GDP. The share of manufacturing, pegged at around 18 percent currently, had been on the rise owing to the government’s focus on investment and job creation. But manufacturing activity has slumped in the past year due to sluggish consumer demand and the weak economy.
The manufacturing growth rate has declined from 12 percent in Q1 FY19 to just 1 percent in Q1 FY20. We believe that revision in tax rates should revive demand across industries and put the economy back on the growth track. The impact on various sectors would differ in terms of how they plan to utilise this fiscal bonus. This could range from reviving investment, lowering prices to increase demand, paying out higher dividends or repaying debt.
FMCG companies may pass on tax benefits to boost volume growth
For FMCG companies, the tax cuts would result in more cash in hand, which could be utilised for spurring demand through trade discounts in the upcoming festival season. To give an estimate, FMCG companies on the Nifty (ITC, Nestle, Britannia, HUL), would see their effective tax reducing from 29-35 percent to 25 percent, leading to retention of a cumulative Rs 2,000 crore earnings on the basis of FY19 numbers. This corresponds to 9 percent of net earnings for FY19.
Credit cycle can get a boost and benefit banks
The finance minister said a new domestic company incorporated on or after October 1, 2019, will pay income tax at the rate of 15 percent. This comes with a rider that production should commence before March 31, 2023. We believe that the move can hasten the private capex cycle and if this happens, credit growth will rise and banks would be key beneficiaries.
However, government borrowing will also go up to make up for the revenue foregone by reducing the tax rate. This in turn would exert upward pressure on interest rates. In sum, therefore, it will have a mixed impact on banks.
The tax measures could particularly be helpful in accelerating investment in chemical and pharma APIs (active pharmaceutical ingredients) business lines as they position themselves for import substitution strategies.
Tax reduction can refuel demand in auto sector
The Indian automobile sector, which contributes 7.5 percent to the country’s gross domestic product (GDP) and 49 percent to manufacturing GDP, has been under the weather for almost a year on the back of multiple headwinds the industry is facing.
Factors such as non-availability of retail finance, liquidity crunch and slowdown in economic activities have hurt demand. But the biggest reason for the lack of demand has been the increase in total cost of ownership led by mandatory long-term insurance and implementation of safety regulations.
How will the tax cuts help the sector? The reduction in tax rates would improve the profitability of companies in the auto industry, but more than that it, may help companies pass on the benefits to the customers in terms of discounts and freebies ahead of the festive season, which may boost demand. Moreover, the move would make more liquidity available to the companies for further investment.
Additionally, the industry is waiting for a GST rate cut on automobiles, which if it comes through would significantly boost demand. However, the GST fitment committee has ruled out GST cut for automakers.