What would be the impact of corporate tax cut on equity markets?
The corporate tax cuts are significant pro-growth measures that aim to improve Indian corporates competitiveness and encourage investments. Further, government officials have stated that more measures to improve growth are likely in the coming months. The equity markets would definitely view these measures positively.
Markets have reacted positively to this change, how long do you think the market would be upbeat.
The measures improve cash flows to corporates and make more cash available for investments or debt repayment. Also, with lower tax rates, IRRs of projects improve encouraging investments. Government has also stated that more measures to improve growth will follow. These measures are not aimed to give a short term boost to demand or concessions to some troubled sectors. They are for the whole corporate sector and hence the impact will be more longer term. Hence India’s longer term growth outlook has certainly improved with these measures and I think markets will take cognisance of this.
How do you think corporates would utilize the surplus?
Corporates can use the surplus
- To invest in their business to improve productivity and / or add more capacity
- To pass on the benefits to consumers, by cutting prices or adding more features To their products at same prices
- To reduce their debt burden
- To increase dividends / share buybacks
- Just pile up the cash on their balance sheet and increase treasury investments
I think the economic benefits of first four options are much better and most corporates would adopt any of the first four options, depending on their individual business situation.
What could derail the markets from here? What are the key risks for the markets?
Key risks for markets remain any sharp rise in oil prices, significant slowdown in global growth and increase in geopolitical tensions in the Indian subcontinent.
Which sectors will be benefited due to this move?
The first order impact of lower tax rates will be benefit automobiles, consumers, banks and global commodity sectors as most companies have higher effective tax rates. However, the second order impact will be improvement in economic growth whose benefits will be more broad based.
Which category of mutual funds should advisors recommend their clients considering this move?
We would recommend investment in a multi cap fund rather than a large cap or mid cap fund as it gives enough flexibility to the fund manager to allocate. In the last 18 months, many large cap stocks also have corrected significantly. In many sectors and stocks, valuations are now below long term averages, thus increasing opportunities for bottom up stock picking. Also, while mid caps have corrected from peak, their valuations are not really at very low levels, unlike 2013. Therefore, we would prefer a multi cap fund.
What are the changes that you have made to your portfolio to benefit from this move?
We have been increasing our allocations to cyclical sectors in the last two months as markets were undergoing correction and valuations were becoming more attractive. These announcements would further increase our positive bias towards cyclicals and sectors geared to benefit from higher economic growth.
It is likely that the government would breach its fiscal deficit target due to cut in corporate tax. What will be the impact of this move on debt markets?
The move is likely to increase fiscal deficit by a large margin (tax shortfall estimated at Rs.1.45 trillion) and government bond yields have risen post the announcement. The rise in yields has been contained so far as government can adopt some other measure (strategic divestment of PSUs, foreign currency bonds etc) to reduce the impact.
What are the other measures that could boost Indian equity markets?
Reforms in factors of production (labour laws and land acquisition regulations), measures to improve basic infrastructure sectors (pricing of infrastructure services on commercial principals, more private sector participation) and strategic sale on PSUs that are in business are some of the other measures that can boost equity markets.
