Corporate tax cuts:What does it mean for Equity Markets?
The RBI,starting February 2019 started a big monetary easing cycle by cut repo rates 4 times to a total of 110 bps.
The growth in Q1FY20 had fallen to a mere 5%....and the pressure was mounting on the the government to provide some fiscal measure to combat the slowdown.
Last Friday the government surprised everybody by announcing a corporate tax cut to 22% for all existing companies and 15% for all new manufacturing companies set up after 1st October!
While this makes India becomes globally competitive with countries around the globe W.r.t. taxation
While for new manufacturing plants the 15% tax that India now offers is the lowest in the world.
So What does this tax cut mean for the Equity Markets?
The corporate tax reform is a fiscal measure by which the government will hand over 1.45 lakhs.
The corporate tax rate cut will increase the fiscal deficit to 3.8-4.0%.Many economists are creating a lot of noise over increase in the deficit.However with companies trying to relocate from China due to the US-China trade war....this is the golden opportunity for countries like India to boost manufacturing by providing big incentives.Therefore the move by the government is a correct one for long term growth of "Make in India".
For the equity markets this is a relief in the sense that markets now know the government is ready to do anything and everything to revive growth.
Let us Analyse the biggest winners of this tax change where investments can still be made.
Private Sector Banks and NBFCs
The Strong becoming stronger and the weak becoming weaker!
Most Profitable Private Sector Banks pay Taxes in the range of 31-33%.
These companies will be the biggest winners of this change as the rate goes down to 25.17%.
The profits for these companies will rise anywhere between 10-15%.
This tax cut coupled with the crippling NBFC crisis and the inability of the PSU Banks to Lend will mean the strong Private Sector Banks are becoming stronger!
Marquee Private sector banks will continue to do very well over the next 3 years and investors must keep a watch on them!
In the NBFCs the strong NBFCs are continuing to do well and will gain market share.Therefore investors must also keep a watch on them.
Most consumer companies also pay tax in the region of 30% and stand to gain from the tax cuts.
Besides this if new companies are set up the tax rate of 15% will mean massive gains!
The Auto Sector is plagued by demand issues....is again a big beneficiary of the tax cut.
Most companies pay tax in the region of 30% and the tax boost will help easing the pressure on the bottom line witnessed over the past months due to lack of demand!
Companies like Bajaj are already exploring the possibility of floating a new company with foreign partners to tax benefits of the 15% taxation.
Sectors which wont gain:-
Most IT companies already pay taxes in the region of 22-25% so dont stand to gain benefit from the tax change
Pharmaceuticals and Healthcare
Most Pharma companies have a lower tax slab and dont stand to gain.However hospital and healthcare companies stand to gain massively from the cuts.
So how to approach Markets now?
The equity markets saw a sharp correction over the past 18 months due to the perception that the government will not take any fiscal measures to improve the economy!
This has clearly changed with this tax reform and with government's intention to bring about more reforms the sentiment will further improve from here!
While the tax reforms will improve the earnings of many companies, most companies will siphon off the money giving little money back to the shareholders and the end consumers!
However good companies will return the money back to the shareholder and consumers!
As the quarterly results are declared,Investors must question the companies on how they will use the proceeds!
To summarise this is a bold reform which has the potential to attract companies to manufacture in India.
However the government must follow the tax cuts with Land and labour reform so that companies have a seamless experience.
Disclaimer:-The author of this report is a Chartered Financial Analyst(CFA) from CFA Institute,USA,the views expressed in the above report are personal and at no point should be construed as an investment advise.Please consult your financial advisor before making any decisions.Reproduction of the above report is strictly prohibited.
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