Will the recent corporate tax cuts help the economy?

The government finally blinked as it announced a slew of measures to help kickstart the slowing economy. Finance Minister Nirmala Sitharaman announced a reduction in statutory corporate tax rates from 30% to an effective rate of 25.2% spreading cheer amidst India Inc. This is not all, the FM also announced tax cuts for new manufacturing businesses, exemptions for FPIs and broadened the scope of CSR spending.

But it remains to be seen whether these steps will provide enough impetus to the economy to get to the high-growth track once again. Let’s analyze the major decisions taken and how they are likely to help.

What are the major problems with the economy?

While India has been one of the fastest-growing developing economies in the world, it has slowed down considerably over the last six quarters. The growth rate climbed down to a low of 5% in the latest quarterly GDP numbers. This implies that for India to sustain even a 7% growth for the current financial year is going to be a heavy task.

The growth slowdown is due to multiple factors. Major manufacturing industries are slowing. NBFC crisis led to a dampening of borrowing activity as banks become more cautious about lending and the liquidity crunch in the market continues. Meanwhile, consumer-led sectors such as Auto and FMCG are seeing a demand crash of immense proportions. Inventories have been piling up and companies have been forced to lay off workers and/or shut factories for as many as three days out of five during a week.

All this and more led to a continuous drop in stock market indices as companies saw immense selling by both domestic and foreign investors. The bearish sentiments spooked the markets further and Nifty dropped below 11,000 levels signalling erosion of lakhs of crores of shareholder wealth within a matter of months.

How will the latest measures help?

The biggest step taken by the government recently is to reduce the effective corporate tax rate from more than 30% to just above 25%. This will immensely help large companies who would have otherwise reported losses to limit losses and some may even report a profit.

A list of major companies paying the highest tax rate which will benefit the most is provided below.

 

Moreover, banks are going to be the second big beneficiaries of this move as they don’t have any profit exemptions and this tax cut will help them add more than 10% to their profitability. Many hope that this will boost sentiments in the sector and some part of this money saved on taxes will be used in lending to the customers.

Similarly, the government’s decision to forego capital gains tax on certain asset classes for both domestic and foreign investors will boost the market and get more people to buy Indian securities. Indeed, the Sensex responded favorably on Friday and saw a bull run in late market hours which brought back some of the wealth for shareholders.

So, is this all that we needed?

While the current measures have provided a one-time booster shot, most experts agree that there’s a need to do much more if the positive economic sentiment has to be sustained. Most importantly, India’s slowdown is not supply-side but rather demand-led i.e. consumer demand is crashing because of lack of money in the hands of the buyers.

Many argue that companies may not pass on the tax savings to consumers in the form of low prices which would mean that the slowdown in consumption is likely to continue as lower prices are known to boost demand. However, products such as appliances and electronics continue to record growth in their sales numbers, thanks to platforms such as the Bajaj Finserv EMI Store which allows people to buy through monthly instalments.

Some experts argue that there needs to be a follow up of these measures with big bang reforms throughout the economy. These include reforming the GST, land and labor laws as well as company laws to actually make doing business easier and spur an investment cycle.

Can the country take the revenue hit due to these tax breaks?

The government estimates that these measures will cost the exchequer Rs 1,45,000 crore in foregone revenue. Initial estimates suggest that India’s fiscal deficit is likely to surge by at least 70 basis points to 4% of the GDP in the year 2019-2020 because of these measures. This is not going to go well with international credit rating agencies which have always been critical of any breach in fiscal deficit targets but the government is hoping that these measures will compensate for any damage to the economic engine of the country and help in the long term.