#Market Strategy — 23.09.2019

Has Modi Re-Found his Mojo? Unexpected surprise tax cuts boost reform agenda in India

Prashant Bhayani & Grace Tam

What Happened?

On September 20th, India’s Ministry of Finance announced a surprise corporate tax cut from 30% to 22%, resulting in an after surcharges effective tax rate of 25.2%.

In order to grow domestic manufacturing and to be in-line with PM Modi’s “Make in India” initiative, new companies which are incorporated from 1st October 2019 will see headline tax rate reduced from 29% to 15% (and an effective tax rate of 17%) as long as production is started before 31st March 2023. Foreign companies would also benefit from these tax changes.

This will be attractive for any shifts in supply chain as companies navigate the current turbulent trade environment and is positive for India’s foreign direct investment in the long term.

Importantly, the announcement follows a number of new measures taken over the past four weeks including exporter tax benefits, combination of SOE banks, and changes in the housing sector.

The optics were important as this was announced just before PM Modi’s gala trip to the US (President Trump attended as well as) where he spoke in front of circa 50,000 people in Houston over the weekend. 

This was the largest gathering in the USA for a foreign leader since Pope Francis.  The US and India are also in renewed talks on trade.

What do we Think?

The move to cut the corporate tax rate in India was unexpected and positive given the negative economic news and sentiment in India. 

This is the type of long awaited reform investors have been waiting for from the Modi government. Given the fiscal issues it was a surprise, back of the envelope it could boost profits of the Nifty by circa up to 9% if none of if given back in lower pricing.

Given the challenging macro environment we would expect some give back in pricing so perhaps closer to 6% in profits.

Of course, the tax cuts in the absence of cuts in spending elsewhere would result in some fiscal slippage. Risks are still there including the slowdown in the shadow banking sector, and declining consumer sentiment with auto sales falling.

However, the tax cut can improve investor sentiment given the selling by foreigners in the past few months and high cash positions in domestic funds. Valuations are more attractive in India after the sell-off with MSCI India trading at 18x forward earnings.

We reiterate our overweight on India with reforms being a key catalyst. This is the first significant reform for investors since the re-election and long awaited.

The market has moved up to reflect the positive impact of this on Friday. However, we would accumulate positions in India over time and look to build an allocation.  The reform measures help to put a floor after the recent sell-off in equity markets.