The tax cut party continues at bourses

The party at the bourses kicked off by cuts in corporate taxes announced on Friday appears far from over.

After touching 39,441.12 points during intra-day trade on Monday, the S&P BSE Sensex ended the day’s trade at 39,090.03—2.83% higher than Friday’s close. The intraday gain was 3.75%; compare Monday’s high with the closing figure on Thursday and the difference is 3,347 points—thrice that of Monday’s closing gain.

The Nifty 50 index ended the day’s trade 2.89% higher at 11,600.20. Compare Monday’s high with Thursday’s closing figure, the gain is 9.25%, and 8.39% when the day’s closing figure is considered.

The S&P BSE MidCap registered over 1,358 points (+10.22%) increase when compared on high to closing, while the closing to closing comparison reveals over 1,269 points (+9.55%) increase between last Thursday and Monday. Similar changes for S&P BSE SmallCap index are over 882 points (+6.94%) and over 861 points (86.78%) respectively.

Investors and equity analysts are both bullish about the government’s surprise move. Ridham Desai and Sheela Rathi, both equity strategists for Morgan Stanley India, think that the corporate tax cuts create room for improved earnings growth. “We raise our earnings growth estimates for the BSE Sensex to 25% in FY2020 and 23% in FY2021 and raise our BSE Sensex target to 45,000 by June 20,” the analysts noted in a September 22 equity strategy note.

“We expect India’s earnings growth revisions, in terms of both depth and breadth, to turn sharply positive after almost nine years of downgrades,” they added. While rate cuts, privatisation, foreign portfolio investors (FPIs) limit increase, and sovereign bond issues are some of the positive triggers in view of Desai and Rathi, the key risks are in the form of global recession, higher oil prices, and higher non-performing assets (NPAs).

But economists are not as bullish as equity strategists. On the government’s decision to meaningfully lower corporate tax rates, Morgan Stanley India’s economist Upasana Chachra is of the view that it sets the stage for improvement in capex outlook, though with a lag. “We expect GDP growth to pick up to 7.1% in QE (quarter-ending) Mar-21 from 5% in QE Jun-19,” Chachra notes in a Sept. 22 report. “In the initial phase, the lower corporate tax rates should help to improve sentiment and the corporate sector balance sheet position,” Chachra added. Further, in her view, the cuts should support the business environment, improve competitiveness and help attract foreign capital.

Chachra opines that this should eventually set the stage for a pickup in capex. “To the extent that the starting point for the corporate sector is challenging, we expect private sector capex to recover in the next 12-18 months,” she added. However, Chachra expects that orders for capital goods may start to see an uptick in the next six-nine months. “The focus of fiscal stimulus is capex-driven rather than consumption-driven and thus poses limited risks to macro stability,” noted Chahcra, who expects inflation to remain near the RBI’s target level of 4% in next 12 months, and eventually expects two more rate cuts by March 20. Earlier, Morgan Stanley had expected two to three additional interest rate cuts from the central bank.

According to a September 21 economic note by Kotak Securities, analysts Suvideep Rakshit, Upasna Bhardwaj, and Avijit Puri noted that the lowering of corporate tax rates testifies to the government’s preference for growth through the investment cycle rather than consumption. Further, the trio notes that India also moves towards corporate tax rate parity with its Asian peers and removes a key hurdle for companies looking at an alternative/in addition to China for manufacturing. “Impact on growth will see some lag, depending on how companies use surplus while fiscal slippages will weigh on bond markets in the near term,” the trio noted.

The Kotak Securities’ analysts also highlighted that after accounting for a reduction in corporate tax rates, weak GST and income tax collections in FY2020, the net tax shortfall is likely to be around ₹1.7 lakh crore—0.8% of GDP—₹ 58,000 crore of which would be offset by extra dividend from the Reserve Bank of India. “Improved profitability of PSUs as a result of tax rate cuts could also augment the dividend payout to the government,” the trio noted further.

Away from the government and government-owned enterprises, for the larger India Inc., the Kotak Securities trio opines that besides retaining the additional surplus, companies can opt for either (or a combination) of investing in (new) capacity, pass on (the surplus) to customers, use it to deleverage, and distribute it through buy-backs or dividends. “With current capacity utilisation of manufacturing companies at around 75% and persistent weak demand conditions, investments may not be undertaken in the near term (though new entrants/exporters will be incentivised due to lower rate),” the trio noted. “Unless a majority of the surplus is passed on to the customers, consumption demand is unlikely to see much impetus in the near term,” the trio noted further. Kotak Securities maintains its estimated GDP growth rate for FY2020 at 5.8% while any pick up could be seen in the latter part of FY2020.

According to Suyash Choudhary, head of fixed income at IDFC Mutual Fund, the government has resisted an easy consumption stimulus which may have had very little multiplier effects and possibly may have eventually contributed to some macro-economic imbalances. “Rather, the tax cuts will help improve corporate profits and hopefully improve our global competitiveness,” says Choudhary who also opines that incentives for new units announced may also help with attracting some of the global supply chains reallocations that are underway given escalating trade tensions. “However, this may not necessarily be a substantial shot in the arm for near term growth prospects,” he warns. “The immediate pass through and growth impulse created may be not as strong and thus the tax buoyancy hoped for on the back of stronger growth may have to wait for a while,” he adds.

Like most economists, Nomura economists Sonal Varma and Aurodeep Nandi do not expect lower corporate taxes to have any meaningful near-term growth impact as they will boost corporate profits and sentiment, but are unlikely to trigger investment given global uncertainties and balance sheet headwinds. “However, this is a medium-term positive step,” the Nomura duo noted. Varma and Nandi opine that the announcement of a lower corporate tax rate has revived depressed corporate sentiment and it will aid higher corporate profits and improve their credit profile. “However, companies’ gains are the government’s losses,” the duo point out. “Given leveraged balance sheets, low capacity utilisation rate and an uncertain global environment, we doubt companies will kick-start capex or that the benefits will be passed onto consumers in any meaningful way,” the duo added.

Aside from macroeconomic developments, market experts are advising caution. “The Indian markets are trading near peak valuations so we would remain cautious on the markets and expect it to consolidate in the near term,” says Ajit Mishra, vice president, research, at Religare Broking. Mishra opines that the recent announcements made by the finance minister are definitely positive for the Indian economy from a long-term perspective. “Hence, investors should focus on accumulating fundamentally sound stocks,” Mishra advises.

Shrikant S. Chouhan, senior vice-president, equity technical research at Kotak Securities, highlights that on an intraday basis, Nifty has reached extreme resistance level which was at 11,700. “We need to be cautious while adding long positions at current levels,” says Chouhan. “Put/Call ratio is at 1.48 (times) and India VIX (volatility index) at 17% which indicates high risk in creating long positions on Indices,” Chouhan adds.

On September 20, FPIs were net sellers in equity to the extent of ₹744.78 crore ($104.7 million). However, on Monday, FPIs were net buyers in equity to the tune of ₹592.64 crore ($83.54 million). On Monday, the jump in FPIs’ gross buying and selling values at ₹17,191.73 crore and ₹16,599.09 crore respectively is eye-catching when compared to Friday’s ₹1,656.21 crore and ₹1,364.02 crore respectively. The 10.38 and 12.17 times increase in gross buying and selling each on Monday indicates that it is high time, that sanity returns to markets which seem to be celebrating an extraordinary event which has the potential to bring positives in the medium to long term.