Faced with rising criticism on deepening economic slowdown, falling GDP growth over last eight quarters and pessimism in corporate India over slowing demand and dipping sales, last Friday the government announced a big bonanza for Indian businesses in the form of reduction in basic corporate tax rates. Aimed at lifting business sentiment and spur investment, finance minister Nirmala Sitharaman slashed corporate tax rate to 22 per cent from 30 per cent for domestic companies and proposed a competitive 15 per cent rate for new investment in manufacturing. The bold move to slash corporate taxes to a historic low will offer a 1.45 lakh crore bonanza to domestic businesses which, as a result, will be a revenue loss for the government.
India’s current corporate tax rate for companies with over Rs 400 crore turnover is officially 30 per cent, exclusive of cess and surcharge. The effective tax rate is 34.9 per cent. With new tax proposals becoming applicable from April 1, 2019, the effective tax rate for these companies will be 25.17 per cent. New manufacturing companies set up after October 1, 2019, can opt to pay only 15 per cent income tax, if they don’t claim exemptions and incentives; the effective tax rate for these firms will be 17 per cent. Besides this, surcharge imposed in the budget on July 6 on capital gains on sale of shares or units of funds has been withdrawn. This benefit will also be enjoyed by Foreign Participatory Investors.
Since the budget on July 6, business and investment sentiment has been quite low. The equity market was on a downward spiral and the government has been under pressure to go beyond sector-specific concessions and remedies. The sharp slide in growth in the June quarter had led to a concerted criticism by the opposition, economists and financial experts that the Modi government had mismanaged the economy, while the government defended itself by taking refuge in global trends as a reason for the slowdown in domestic economy. As growth stuttered, subdued consumer sentiment and sluggish investment were at odds with the confidence and popular expectations that the Modi government’s emphatic return to power would mean business-friendly environment and growth-oriented policies to attract domestic and foreign investors.
With auto, FMCG and other consumption industries’ woes capturing headlines in recent weeks, there was a clamour for sector-specific relief in tax rate. Not admitting the slowdown and blaming it on global factors rather than self-inflicted problems, the slide in business activity, investment and downbeat mood in equity market needed some hard steps to counter the growing negative political narrative. Thus, the calculated gamble of reducing corporate taxes and offering the option of opting out of exemptions has had the desired effect of boosting business and market sentiment. Not surprisingly, the equity market, which was used to getting some announcement by the finance minister every week aimed at boosting the slowing economy over the past few weeks, recorded its second biggest rise ever on Friday.
While the equity market often reacted negatively to government’s earlier announcements since August 23, the radical changes to taxation rules which were announced on Friday morning were a good reason for the market to rise relentlessly through the day, adding Rs 7.1 lakh crore to investors’ wealth. Apart from growth-oriented reforms and policies, the corporate profitability is the biggest driver of sentiment for equity market. Since the rate cut in corporate tax has the potential to boost net profit for several leading companies by an average of about 5 to 7 per cent, the BSE Sensex ended the day with 5.3 per cent gain. The dual-track system of taxation–keep your exemptions at existing rates and pay 25.17 in taxes or switch to a new regime and pay only 22 per cent–besides the hope that the relief to corporates will revive investment, generate jobs, expand corporate tax base and fresh foreign investment added an element of thrill to the extremely bullish sentiment on the bourses.
But will the government’s mini-budget-like proposals perk up India Inc which has been feeling gloomy over the last few months? Initial reactions of several leading industry captains have been extremely positive. They expect the respite in direct corporate taxes to give required stimulus to the economy and make Indian companies more competitive. Some expect the steps to help kick-start the next big economic up-cycle and make India the hottest investment destination. But these are initial reactions, sparked by euphoria over absolutely unexpected tax measures. However, when the euphoria wears off and all mathematical calculations are done, the question remains whether the drastic measures will reverse the economic slowdown and set right India’s growth trajectory.
India’s economy, according to experts, currently has a problem on the demand side: people are reluctant to buy enough. This had led to under-utilization of production capacities in several sectors. What the government has done is reduce corporates taxes, which will boost corporate earnings. But the demand side issue remains, unless corporates pass on the benefit to consumers in the form of reduced prices. Whether this will happen remains to be seen. Supply side measures may not spur investment, unless demand picks up, which requires putting money in the hands of consumers. This is where the role of poorly structured GST comes in. With too many tax slabs, rationalization of rates is unlikely to happen anytime soon. This is hurting both consumers and businesses, as also the economy which is mired in the vicious cycle of lack of demand, stalled new investments and increased unemployment.
The government’s bold steps in reducing tax on corporate income will have an impact on fiscal deficit. The finance minister has said the tax cuts will result in Rs 1.45 lakh crore loss to the exchequer in the current fiscal. This is expected to increase the fiscal deficit by 0.7 per cent to 4 per cent of the GDP as a direct result of the move. Where will the money come from to fund the stimulus package? A day before the tax cuts were announced, RBI governor Shaktikanta Das said there was little space for any fiscal expansion like a tax cut. But the government has done the damage and hoping to repair it in the long run by bringing in more investment and boosting government revenue.
The writer is an independent Mumbai-based senior journalist.
