The sudden changes announced in corporate tax structure last
week galvanized the Indian stock markets. It has turned the sentiments by 180
degrees from extreme pessimism to extreme optimism within a matter of few
hours.
Not only the stock market participants, but all the corporates
have also been positively surprised by this sudden announcement. The move has
been welcomed by businessmen almost unanimously.
The decision to change the structure of corporate tax is not
totally unexpected as this structure has been part of almost all versions of
"New Direct Tax Code" that has been a work in progress for past one
decade at least. However, the timing and method (through Ordinance) just
2months after announcement of full budget caught the markets by surprise.
Many readers have asked for my views on this decision to
suddenly change the corporate tax structure, which I am happy to share as
follows:
(a) I believe this decision
is very good.
It shall serve to enhance the competitiveness of Indian
businesses (i) as exporter of goods and services and (ii) manufacturing
location for global corporations which are either looking to diversify their
manufacturing facilities away from traditional bases like China and Malaysia
etc., or want their manufacturing closer to their target customers in South
Asia.
The new structure being a simple one shall also lead to
significantly less litigation and disputes.
Since the new structure does away with exemptions and incentives
related to SEZ, Backward Area investment etc. it could lead to significantly
more efficient industries. This combined with GST and improved logistic
infrastructure, may enhance the efficiency of Indian industry materially.
(b) In my view, this change
in corporate structure is primarily aimed at attracting FDI in manufacturing
and must be based on the expression of interest and/or feedback of global
corporations.
It is basically a supply side measure and may not immediately
result in higher consumer demand. If the stock market reaction and analysts
forecast revisions are to be believed not many companies shall be passing on
the benefit of lower tax to the consumers.
In my view, however the assumption of 1 to 1 gain in profit
after tax (PAT) is totally unjustified. The gains, if any, will be shared
between the consumers and shareholders. A 2-3% cut in tax liability therefore
may not result in 2-3% higher PAT.
Therefore, the government may need to supplement these changes
in the corporate tax structure with changes in personal income tax and GST to
aid the consumer demand.
Insofar as investment demand from the domestic companies is
concerned, the current capacity utilization level do not augur well for further
capex. We may see some revival in investment demand only towards second half of
next fiscal in my view.
(c) To make the new
corporate tax structure sustainable and credible, the government must almost
immediately announce an aggressive disinvestment plan that involves
privatization of a large number of public sector enterprises (PSEs). The
practice of disinvestment through book entries (one PSE buying the other or buy
back of shares) may not be sufficient to fill the fiscal gap that may be
created by the new proposals.
(d) The other countries
vying for the business fleeing China, e.g., Indonesia, Vietnam and Thailand etc
al. have also cut corporate tax rates to stay competitive. Therefore, only tax
rate cut may not be sufficient motivation for the foreign businesses.
The government must follow this up with adequate non fiscal
measures like easier land acquisition norms, necessary labor law changes and
perhaps higher degree of INR convertibility.
These changes need to be considered and implemented promptly
before the investment decisions are taken by the target global businesses.
I am sure the "surprise" has not been a pleasant one
for many of the market participants. I know a lot of traders are caught on the
short side.
The option writers in particular may have suffered "once in
a decade" 6 or 8 sigma event that snatches away a large of profits made by
the whole decade. If my memory serves me right, last time an event of this
magnitude occurred in 2008. A lesser degree event occurred in 2016.
Besides, many investors who had decided to sit and wait on the
sidelines have also been caught totally off guard. Most of them could be heard
regretting the missed the "opportunity".
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