Economic growth and corporate earnings set for revival

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Challenging environment calls for bold reforms. This was precisely what Finance Minister Nirmala Sitaraman delivered on 20th September. The cut in corporate tax rates and MAT and the new manufacturing tax rate came as an unexpected shot in the arm for the economy and markets. Sensex and Nifty responded with spectacular rallies of 1921 and 529 points respectively- the best during the last 10 years.

The major factor that pushed India’s GDP growth rate to a six year low was the decline in private investment, which has been declining steadily during the last six years. The corporate tax cuts announced, along with the monetary stimulus already provided by the RBI, have the potential to trigger the animal spirits and revive investment and economic growth.  The 22 percent corporate tax rate (25.17 percent effective rate including cess and surcharge) makes our tax rates competitive and in tune with most emerging markets and our Asian peers. The new tax rate of 15 percent for new manufacturers can attract fresh investment and give a big boost to ‘Make in India’. The reduction in MAT is welcome. These tax cuts will leave more money with the corporates for investment and remove the negative image of India as the nation with the highest corporate tax rate. The psychological boost from these bold reforms will be significant.

The market has given a big thumps up to the reforms, which can be described as the most path breaking and reformative after Manmohan Singh’s path breaking budget of 1991 and P Chidambaram’s ‘dream budget’ of 1997.  The benchmark indices Nifty and Sensex have delivered the best single day gain of the last 10 years. The ‘wealth effect’ of the market gains also can contribute to stimulating demand. From the capital market perspective, the announcement that the enhanced surcharge will not apply to capital gains on sale of equity, derivatives or equity oriented funds and the removal of tax on buy backs for those companies making the announcement before July 5 this year are clear positives.

The stimulus size is quite big since the revenue foregone is expected to be Rs 1.45 lakh crores. This along with the Rs 20000 crore package for the real estate sector has the potential to pump-prime the economy. Of course, there will be a revenue shortfall and the consequent strain on the fisc. But the expected expansion of economic activity can partly compensate for the revenue shortfall. The fiscal slippage is a risk worth taking. Fortune favors the brave!

These bold reforms, along with the monetary stimulus provided by the RBI, the relief package to the automobile and real estate sectors and the rural uplift expected from the good monsoon have the potential to kick start the economy and push it to higher growth.

 Of course, the external environment needs to be keenly watched. The fact that 20 central banks have cut rates this year is an indication of the challenging global economic environment. Escalation of the geo-political tension in West Asia is another area of concern.

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