In yet another bid to bolster the slowing economy, the Finance Minister on Sept 20, 2019 took a bold decision of slashing the corporate tax rates from 30% to 22% (effective rate inclusive of cess and surcharges 25.17%) for existing domestic companies and 25% to 15% (effective rate 17.17%) for new manufacturing companies. Further, the MAT rate was also cut down from 18.5% to 15% for all domestic companies.
The announcement was appreciated by all major corporate houses and industry experts alike. The Dalal street cheered the move wherein the S&P BSE Sensex logged its biggest single day gain of 5.3% in a decade (estimated wealth creation of ~ Rs 7 lakh crore). Industry estimated that the move would directly impact the Earnings per Share (EPS) of major companies having effective tax rate of over 25.17%. Crisil Research in its report published on Sept 22, 2019 suggested that the announcement could see around 1000 companies spread across 80 sectors which contribute one third of the tax paid by India Inc save upto Rs 37,000 crore.
As the announcement stated that the lower tax rate would be applicable only for companies not availing incentives or exemptions, the industry sought clarifications on many issues including the availability of MAT credit and unabsorbed depreciation losses. Central Board of Direct Taxes (CBDT) vide its circular has clarified that the carry forward benefit of MAT credit and unabsorbed depreciation loss shall not be available for companies adopting the new tax rate. However, companies have the freedom to first exhaust their unutilised MAT credit/unabsorbed depreciation losses and thereafter changeover to the lower tax regime.
Intention vs Impact:
The government has certainly made its intention clear that it is committed to economic reforms and shall do all that is required to bring back private investment and improve the investment climate in the country. However, the wait for an economic revival led by a fresh cycle of domestic and foreign investment may still be a few quarters away in view of the following factors:
- Revised tax rates more attractive for new manufacturing companies only: Considering the fact that existing companies won’t be allowed to utilize MAT credit it seems difficult that all existing companies with effective tax rates above 25.17% would shift to the new regime anytime soon. Thus, the general belief that lower taxes would improve profit margins and companies would be left with more cash to reinvest into business has lost steam. The only attraction as far as tax rates are concerned is that for new manufacturing companies which would be taxed at an effective rate of 17.17%. As this tax rate makes India competitive as an investment destination, it may certainly attract some investors who on account of tax arbitrage were moving to other countries like China (25%), Thailand (20%), Indonesia (25%), Vietnam (20%). Considering that the long term consumption story of India is still very much intact, the move is expected to yield results in the coming quarters but not before the overall demand cycle gets revived.
2. Cyclical & Structural Issues: Presently, we are going through a phase which is gripped by both cyclical and structural issues that is keeping private sector capital away from the streets. While the cyclical issues in demand supply mismatch may be managed through monetary and fiscal policy measures it is the structural issues like availability of land and skilled labour, high corporate governance standards, strong banking system, social security, quality education and healthcare etc which need to be addressed through economic and social reforms. These reforms would have a far greater and lasting impact in determining India’s economic growth in the coming decade.
3. Global Slowdown: The Organisation for Economic Cooperation and Development (OECD) estimates that the global economy shall witness its weakest growth since the 2008-2009 financial crisis with a growth rate of 2.9% as against a growth of 3.6% last year. Manufacturing activity has contracted both in the developed and developing economies led by the slowing demand for products. Barclays’ global manufacturing confidence (GMC) index at -0.58 has declined for an eight consecutive month in September 2019. Prevailing trade tensions between US and China has further aggravated the issue and lowered the business confidence and investor sentiment level. Back here in India the RBI has lowered its growth forecast from 6.9% to 6.1%. This, after the GDP growth rate in July fell to a six year low of 5% and the growth in eight core sectors (Coal, Crude oil, Natural gas, Refinery products, Fertilizers, Steel, Cement and Electricity) slumped to a 52 week low of -0.5% in the month of August.
4. Banking sector woes: The faith of general public in Indian banking system seems to be at an all time low. Some banking stocks have crashed by more than 50% over the last few quarters. Data compiled by Bloomberg shows that seven of the world’s ten worst performing bank stocks are from India with Yes Bank and IDBI Bank in the lead. The shadow banking story has been overshadowed by gloom and doom after the IL&FS crisis followed by DHFL, Altico and some more names doing the rounds. As if this wasn’t enough, frauds committed in multi state cooperative banks like Adarsh Cooperative and Punjab & Maharashtra Cooperative Bank have further shaken the depositor’s confidence who are praying hard to get back their hard earned money. The economic woes clubbed by rising NPA’s have turned bankers risk averse who now fear to take any exposure on Greenfield projects and also demand for high value collaterals. This is leading to a situation wherein depositors are losing trust in banks, banks are losing trust in promoters and promoters fear that an immediate reversal in consumer demand for their products may not come through. This situation ought to reverse if private capital is to come back and this may not happen anytime soon given that the banking mess is not showing any sign of bottoming out.
Conclusion:
Though the government is trying hard on its part to instil investor confidence, attract foreign investments and resurrect the ailing economy through measures like lowering tax rates, creating a Rs 20,000 crore fund to revive the housing sector, promote exports, ease liquidity in system and lower cost of funds through the central bank, these measures may not have any immediate impact on the consumer demand for manufactured products which is the actual cause of slowdown. Private capital will not come in unless they see a real time demand revival and demand will get generated only when consumers have that extra bit in hand to spend. With employment levels dropping along with slowing economic activity the common man is uncertain about his future income and its growth prospects, which is making him averse to spending. The negative news from all sectors is further dampening the investor sentiments while making the consumers more cautious.
In the coming weeks though we may expect the government to announce additional measures on its part to bolster economic sentiments, however, on account of the reasons stated above it may take a little while for the economy to witness a new era of high growth.