In our view, these reforms represent a significant change in policymakers’ economic approach: Previously, the government favored using monetary policy to boost growth, but this announcement signals that fiscal measures will now be a part of its policy mix.
The announcement marks a decisive shift in the government’s approach toward managing growth. We believe it’ll raise income and savings for businesses, accelerate investment—both domestic and foreign direct investment (FDI)—and increase the pace at which the informal economy is formalized. Coupled with other key initiatives (e.g., recycling state-owned assets and labor reforms), this could transform India’s investment environment.
Before the September 20 announcement, the government primarily relied on monetary policy and the Reserve Bank of India (RBI) to boost growth, while maintaining fiscal discipline. However, monetary policy hasn’t been as effective because the transmission of interest rates and credit has lagged policy decisions. This has contributed to the decelerating GDP growth over the past few quarters.
We believe slower growth might have tilted the balance, pointing the government in the direction of fiscal policy. According to our estimates, the tax cuts should translate to an economic stimulus of roughly US$20 billion, or about 0.7% of GDP for fiscal year 2020.3 Importantly, India’s new corporate tax rate should improve its competitiveness relative to most major Asian economies, and the preferential rate for new manufacturing firms will be one of the lowest in the region.4 We believe this policy move decisively raises India’s global competitiveness and will help efforts to attract manufacturing investment, which is consistent with the government’s preference of driving growth through investment rather than consumption.
Overall, we believe these reforms should incentivize greater domestic private capital investment, attract global manufacturing investment to India, create new jobs, and act as a catalyst to an investment-led economic rejuvenation.
Implications of tax reforms
We envisage the following possible outcomes from the reforms:
Boost earnings: Our estimates suggest the announced corporate tax cuts should translate into an 8% to 10% earnings improvement for the listed equity universe5 in India. We believe that businesses will use these tax savings in myriad ways, such as catalyzing consumer demand through price cuts and/or promotions, and investing in additional capacity to take advantage of the lower investment-linked tax rates.
Revival in the capital investment cycle: The reduced base income-tax rate of 15% for new manufacturing investment doesn’t have an expiry date in the near term as long as production starts by March 2023. Since this can translate into significant tax savings of seven percentage points lower than the new standard corporate rate, businesses could likely bring forward their capital investment decisions.
We also note that because of continuing U.S.- China trade tensions, many multinational corporations (MNCs) are looking to diversify their regional supply chains. MNCs could move part of their regional production to India to take advantage of the lower rates. We also believe the lower tax rate is an opening salvo in a package of government policies that may include further reforms on factors of production (e.g., land, labor) and the expansion of end markets through trade agreements (FTAs).
Higher fiscal deficit: As a result of the tax cuts, we estimate that the central government’s fiscal deficit in FY 2020 should increase from 3.3% of GDP to roughly 3.7%.6
Despite an increasing deficit, we expect only mild pressure on both interest rates and the rupee for a number of reasons:
- Global central banks easing should lead to benign liquidity conditions;
- Moderate domestic inflation gives the RBI room to cut interest rates further;
- Real rates for the rupee remain high;
- Global investors could be attracted to Indian equities as growth prospects revive;
- FDI in manufacturing could increase as a result of the tax cuts;
- Domestic tax buoyancy may improve with higher growth; and, last but not least,
- The government can pursue privatization of state-owned enterprises.
Overall, we believe there will be adequate capital to fund the deficit without putting much upward pressure on interest rates. If the government chooses to privatize state-owned assets, it would be, in our view, another big positive for the economy and markets.
"Overall, we believe there will be adequate capital to fund the deficit without putting much upward pressure on interest rates."
In our previous commentaries, we’ve always argued that the reelected administration has the unique opportunity to lift India's growth rate through what we call the “three R’s”—recycling, rebuilding, and reinvesting.7 With the current reforms, we see that the government is moving closer to this framework, which should boost India’s growth rate.
1 “India surprises with $20 billion tax cut stimulus; stocks soar,” Bloomberg, September 20, 2019. The preferential rate is for manufacturing firms incorporated after October 1, 2019, and starting production before March 31, 2023. 2 Bloomberg, as of September 20, 2019. 3 Manulife Investment Management estimates, September 25, 2019. 4 Bloomberg, KPMG, September 24, 2019. 5 Nifty 50 Index. 6 This estimate includes the assumption that some offsets will be available from the higher than budgeted dividend from the RBI. 7 “India’s incumbent government wins second election mandate,” Manulife Investment Management, May 24, 2019. The “Three R’s” are: 1) Recycle—growth could be lifted through selling state-owned enterprise (SOE) assets to fund government spending; 2) Rebuild—building domestic income and savings that could support investment; and 3) Reinvest—providing incentives to manufacturing firms to make investments to substitute imports and increase the global market share of exports.
Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. These risks are magnified for investments made in emerging markets. Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a portfolio’s investments.
The information provided does not take into account the suitability, investment objectives, financial situation, or particular needs of any specific person. You should consider the suitability of any type of investment for your circumstances and, if necessary, seek professional advice.
This material, intended for the exclusive use by the recipients who are allowable to receive this document under the applicable laws and regulations of the relevant jurisdictions, was produced by, and the opinions expressed are those of, Manulife Investment Management as of the date of this publication, and are subject to change based on market and other conditions. The information and/or analysis contained in this material have been compiled or arrived at from sources believed to be reliable, but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness, or completeness and does not accept liability for any loss arising from the use of the information and/or analysis contained. The information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and is only as current as of the date indicated. The information in this document, including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Investment Management disclaims any responsibility to update such information.
Neither Manulife Investment Management or its affiliates, nor any of their directors, officers or employees shall assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained herein. All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment or legal advice. Clients should seek professional advice for their particular situation. Neither Manulife, Manulife Investment Management, nor any of their affiliates or representatives is providing tax, investment or legal advice. Past performance does not guarantee future results. This material was prepared solely for informational purposes, does not constitute a recommendation, professional advice, an offer or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security or adopt any investment strategy, and is no indication of trading intent in any fund or account managed by Manulife Investment Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Diversification or asset allocation does not guarantee a profit nor protect against loss in any market. Unless otherwise specified, all data is sourced from Manulife Investment Management.
Manulife Investment Management
Manulife Investment Management is the global wealth and asset management segment of Manulife Financial Corporation. We draw on more than 150 years of financial stewardship to partner with clients across our institutional, retail, and retirement businesses globally. Our specialist approach to money management includes the highly differentiated strategies of our fixed-income, specialized equity, multi-asset solutions, and private markets teams—along with access to specialized, unaffiliated asset managers from around the world through our multimanager model.
These materials have not been reviewed by, are not registered with any securities or other regulatory authority, and may, where appropriate, be distributed by the following Manulife entities in their respective jurisdictions. Additional information about Manulife Investment Management may be found at www.manulifeim.com/institutional.
Australia: Hancock Natural Resource Group Australasia Pty Limited, Manulife Investment Management (Hong Kong) Limited. Brazil: Hancock Asset Management Brasil Ltda. Canada: Manulife Investment Management Limited, Manulife Investment Management Distributors Inc., Manulife Investment Management (North America) Limited, Manulife Investment Management Private Markets (Canada) Corp. China: Manulife Overseas Investment Fund Management (Shanghai) Limited Company. European Economic Area and United Kingdom: Manulife Investment Management (Europe) Ltd. which is authorised and regulated by the Financial Conduct Authority, Manulife Investment Management (Ireland) Ltd. which is authorised and regulated by the Central Bank of Ireland Hong Kong: Manulife Investment Management (Hong Kong) Limited. Indonesia: PT Manulife Aset Manajemen Indonesia. Japan: Manulife Asset Management (Japan) Limited. Malaysia: Manulife Investment Management (M) Berhad (formerly known as Manulife Asset Management Services Berhad) 200801033087 (834424-U) Philippines: Manulife Asset Management and Trust Corporation. Singapore: Manulife Investment Management (Singapore) Pte. Ltd. (Company Registration No. 200709952G) Switzerland: Manulife IM (Switzerland) LLC. Taiwan: Manulife Investment Management (Taiwan) Co. Ltd. Thailand: Manulife Asset Management (Thailand) Company Limited. United States: John Hancock Investment Management LLC, Manulife Investment Management (US) LLC, Hancock Capital Investment Management, LLC and Hancock Natural Resource Group, Inc. Vietnam: Manulife Investment Fund Management (Vietnam) Company Limited.