Do it yourself

Wednesday, September 25, 2019

1HFY20 - Eventful 6months

The first half of the current fiscal (1HFY20) is almost over. On the domestic front, the past six months have been quite eventful for the country in general, and the economy & financial markets in particular.

Politically, the six month period witnessed the PM Modi led NDA returning to power with unexpectedly strong majority. Continuing with the tradition of unpredictable policy responses, the government has rewritten the rules for engagement with Pakistan and China by abrogating the controversial Article 370 of the constitution. Besides, a definitive move has been made towards implementing a uniform civil code by outlawing the practice of triple talaq (The right of men to divorce their wives instantly through oral or text communication) prevalent amongst Indian Muslims. A long standing dispute over the construction of Sri Ram Temple in Ayodhya has been fast tracked and a final Supreme Court Verdict on the dispute is expected in next 2 months.

These developments have removed some splinters that have been hurting the toe of Mother India for many decades. The procedure to remove the splinters is painful and full recovery may take some time. Nonetheless, if proper care is taken to heal the wound without letting the infection to spread, it will be a major relief for the country in medium to long term.

Economically, the growth continued to decelerate to lowest since global financial crisis. More and more sectors joined the class of slowdown. Three noteworthy events have taken place. The inflation is persisting at the lowest levels in a decade and manufacturing growth has almost stalled. Accordingly, tax collections have fallen much short of the budgeted targets weighing on the fiscal balance.

Firstly, the concept of Universal Basic Income (UBI) has been introduced to supplement the rural job guarantee (MNREGA) that was in place for past one decade.

Secondly, the process to restructure the scheme of income tax has been initiated with restructuring of the corporate tax. The process of simplifying and streamlining of GST has also gathered pace with further consolidation of slabs and classifications. A simplified GST and Corporate Tax structure shall provide a strong foundation for reorganization of Indian enterprises. Eventually, we may see large consumer facing businesses adequately supported by a vast network of smaller feed suppliers, contract manufacturers and service providers etc.

Thirdly, the process of bank consolidation has accelerated with on the tap licensing for smaller banks. This shall straighten the structure of Indian financial system that got distorted post demise of development financial institutions two decades ago. Two separate financing verticals one to finance the growth (infrastructure, projects and corporate) and the other to finance consumer and ensure financial inclusion shall get established in due course of time, of course with some overlap.

Financially, 1QFY20 was one of the weakest quarters in past 8yrs insofar as the corporate earnings are concerned. The asset quality remained under pressure with many some new areas of stress emerging. The household debt levels have increased while corporate have deleveraged.

RBI continued to ease monetary policy with rate cuts and liquidity infusion. The policy stance was changed to "accommodative" from "calibrated tightening" earlier.

The logjam between NCLT and Judiciary continued to plague the process of resolution of stressed assets under IBC.

Financial Markets have been volatile. The benchmark stock market indices are little changed from their six month ago levels, thanks mainly to the massive rally in past few day. INR is weaker by couple of percentage points due to 60bps fall in benchmark yields and FPI outflows.

Tomorrow, I shall present my current investment strategy and market outlook.

1QFY20 weakness driven by both consumption and investment

Business and Consumer Confidence Worsens

Inflation remains benign, signs of bottoming

Monetary easing continues, as growth remains below potential

Corporate Earnings growth remains weak

Bonds yields soften, INR weakens

Tuesday, September 24, 2019

Change in corporate tax structure - What does it mean for me

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".