Corporate tax cuts: Context & Consensus opinion

Amidst all the gloom & doom in the last few months over Indian economy, and FM Nirmala Sitharaman’s frequent press conferences (to an extent that it might have given complex to even TV anchor Lata Venkatesh’s time on air) to calm nerves in the last few weeks, stock markets were sinking and Nifty had closed at 7-month low yesterday at 10700- down 11% from all-time highs hit in Jun-19. The pain in broader market was significantly worse than what was being represented by Nifty (which was helped by IT stocks & few big gainers), with Midcap & Smallcap index down 29% and 44%, respectively, from their peaks they had hit in Jan-18. This performance appeared particularly miserable when compared to global stock markets, which are holding remarkable gains (20%+ YTD), with US markets kissing all-time highs. And it has come despite BJP govt. (perceived to be more market-friendly) getting re-elected with an overwhelming majority in the recent elections (May-19).  

     

To note, Q1 FY20 real GDP growth was 5% (slowest since 2013), and nominal GDP growth was only 8% (17-year low), courtesy low inflation. Also, recent government messaging (FM & Economic advisor to PM), has been that 'socialized losses & privatized profits' is no longer an option to revive economy.   When it was just about time for even hardcore bulls to throw the towel (at least for short-term), in a surprise move, FM has announced corporate tax rate to be reduced from 30% to 22% to revive the economy. And as smartly it could be, this positive news was announced by FM during market trading hours at 10.30am (vs. most of her other announcements post-markets), triggering animal spirits of investors in stock markets, and resulting in 5%+ move today, making it the biggest single-day move (+570 points on Nifty) in the last 10 years, with overall market-cap of BSE-listed firms rising by $100 bn today. Importantly, the reduction in tax announced had no caveats, no hidden clause, no preconditions attached, with a clear intent to revive growth. 

Given sudden change in investors’ sentiment, with some renowned voices (Vallabh Bhansali) calling it ‘the biggest step since 1991’, or few other calling it as ‘bold move’, or as turning ‘vicious economic cycle to virtuous cycle’, or with fund managers (Samir Arora) saying this can drive 10-15% stock market gains swiftly, I thought it is time for me to evaluate the facts closely, appraise the optimism, and ‘try’ to be rationale amidst this euphoria. Tuning into TV debates, or checking into my analyst friends/colleagues, I could not hear even one voice believing that markets might go down again, with most calling new-highs in the next 3-6 months (ceteris paribus in global markets). 

For the beginners, details of tax reduction announcement, and some preliminary questions are well explained in the link here . In simple words, lower taxes →higher corporate net profits →higher EPS → P/E valuation looks low, so market rallies. Further, higher profits can kick start the economy, as more money is now available to plough back/ reinvest in biz. → higher capex spending → more jobs/wage growth → more income in hands of consumer → more consumption demand. And even the least optimistic person will assess it saying corporate (especially in more competitive industries) could pass the tax benefit through lower prices for consumers, who might now consume more than before (i.e. higher volumes offsetting lower prices). 

Amidst this rare consensus among all, I try to split-up the impact of this announcement, with more emphasis on what can go wrong in my next blog, as the positive side of the debate is well-known to all. Like always, my attempt is to not to follow the herd mentality blindly, and check the realistic possibilities. For those, who could comprehend this basics well, I suggest reading the next part.