Last week, the US and European Central Bank successively cut interest rates and implemented a loose monetary policy, which failed to surprise the market. On the contrary, India’s tax cuts have made the market happy, and Indian stock market has risen nearly 10% in two days.
On September 20th, the Indian Ministry of Finance announced a significant reduction in corporate tax rates. This policy is expected to stimulate economic growth in the second half of the 2020 fiscal year, but it will also increase the deficit for the 2020 fiscal year.
Policy details and economic impact
The core of this round of policy is to significantly reduce the existing corporate income tax, from 30% to 22%. The effective tax rate with surcharges dropped significantly from 34.94% to 25.12%. The new tax rate will take effect immediately. Secondly, the newly established domestic enterprises after October 1, 2019 will invest in new manufacturing and guarantee the production before the end of March 2023. The applicable tax rate will be further reduced to 15%, and the actual effective tax rate is only 17.01%. In addition, there are also preferential rates for minimum alternative tax rates, capital gains tax and corporate repurchase tax.
Tax cuts will stimulate the Indian economy from different angles. First, the Chinese trade war currently affects global manufacturing companies to redistribute their supply chains. India is currently introducing preferential policies that will likely absorb foreign capital into India, especially those affected by the Sino-US trade war. After this adjustment, the Indian tax rate has regained some appeal in major Asian countries. In particular, the newly established manufacturing company has a tax rate of only 15%, which is the lowest among the major Asian countries.
However, large-scale tax cuts have intensified fiscal pressure on the Indian government in the short term. India has been affected by the double deficit. The IMF also mentioned in the April global economic outlook that India’s government fiscal deficit will reach 6.9% in 2019, which is at a high level in the world. This tax cut will further push up the deficit rate and increase financial pressure. If the stimulus policy is effective, GDP growth will increase fiscal revenue and ease fiscal pressure.
Market impact and investment outlook
The market has a positive impact on policy. In the stock market, India’s main index rose by more than 5%. The market expects that corporate tax cuts will significantly increase corporate profits for the year. The bond market is under pressure. India’s 10-year bond yields rose 20 basis points to 6.85%, as the market believes that the Indian government’s fiscal deficit to GDP ratio will exceed the previous estimate of 3.3%. The foreign exchange market is neutral and optimistic. After the news of the tax reduction policy was announced, the Indian rupee rose slightly against the US dollar.
In the long run, the Indian market is still attractive. Under the Sino-US trade war, policy stimulus will give rise to opportunities for foreign investment. India and China have similar land and demographic characteristics. India can imitate China’s development of the real estate market and increase the leverage of wealth.