Has Nirmala Sitharaman ushered in next Big Bang?
This was the fourth Friday and there had been some sincere attempts at reforms in the previous press conferences. But even on Friday morning, there was no indication of the Big Bang coming up. Here is what excited the markets a great deal.
- In a surprising move, the Finance Minister slashed corporate tax rates from 30% to 25%. Even considering the overall cess of 3%, the total effective tax rate will be only 25.17%.
- There is another alternative that the Finance Minister has offered. Instead of the 25% tax rate with all exemptions, the company in question can opt for a flat rate of 22% without exemptions. This is useful for companies that are not claiming too many exemptions at this point of time.
- The above exemptions pertain to existing companies. However, in case of companies that commence manufacturing operations after October 01, 2019 but before 2023, the tax rate will only be 15%.
There are a lot of benefits that are likely to flow from the tax rate cut. Remember, this was a promise that was made by Arun Jaitley in his 2014 budget but the exemption was only offered for companies with turnover up to Rs250cr. This was later increased to Rs400cr in the 2019 budget by Nirmala Sitharaman. Now, this big bang announcement could have multiple implications.
- This will simplify the entire tax process because more than 50% of the companies in India are already paying less than 30% effective taxes. Here you have a much simpler formula without all the accounting hassles.
- On the positive side, this will release funds to the tune of Rs145,000cr and that is likely to be used by companies for expansion and for exploring new markets. This could also provide a boost to demand and have a salutary impact on consumption.
- There is a downside risk to this move too. For the government, this will entail a revenue loss of Rs145,000cr and with the budget already severely constrained, it remains to be seen how the government is able to make up the short fall in revenues.
- The real big bang could be for the start ups and the make in India program. Now companies have the incentive to set up new manufacturing post October 2019 and that could literally trigger a virtuous investment cycle in the economy. If that happens, then the revenue loss would be more than covered. The make in India program was largely constrained due to the skewed tax structure. This should correct that and encourage a lot more of investments through the domestic and the FDI route.
Well, they have reacted already. It is hard to recollect when was the last time the Sensex was up by 2,000 points in a single day. But there is a smart case here. The tax cuts will straight away release Rs145,000cr for Indian corporate sector. Apply an average valuation of 20x for the Nifty, this translates into additional value creation to the tune of nearly Rs29 trillion. In dollar terms, that is more than $400 billion of value and on a market cap of $2.5 trillion, that is nearly 15-20% potential upside in the market value.
There is one risk in the entire story. The government revenue shortfall post the tax cuts should not result in additional borrowings as that will crowd out private borrowings and push up interest rates. For Indian corporates, that could really be a double whammy. On the one hand it adds to their solvency risk and on the other hand it reduces valuation by raising cost of capital. One will really have to wait and watch if the GST Council meet later in the day also backs up these announcements with a consumption boost?