Post the huge cut in corporate tax to boost investment and confidence of private sector, market is considering a dilution in fiscal deficit from the original target of 3.3% to a range of 4.0% due to loss of Rs1.45 lac crore from corporate tax in FY20. The outcome will depend on the government’s plans to source other income from divestment as an important resource to reduce the gap and higher dividend from Public Sector Companies and RBI. If these plans are not successful, it will impact government spending impacting economic growth. No clear direction from the government while sticking with the last fiscal target, provides a vague situation hurting the sentiment of bond market. India’s 10 year bond yield has inched up by about 50bps in the last 2.5 months anticipating higher government borrowing in the future. This may heavily impact the equity market too in the future which has rallied in a quick fashion due to unexpected cut in corporate tax increasing earnings without any economic efforts. Post the announcement, Nifty50, Nifty Midcap and Nifty Smallcap grabbed by 10%, factoring about ~10% hike in EPS during the year. Today market is consolidating losing about half of large-cap and 3/4th of Mid and Smallcaps gains, given weak economic data like core sector, auto sales, WPI and NPA, showing that ongoing slow trend may continue longer.
This tax measure will not have an extra benefit for mid and small cap stock but for companies at high tax bracket. Whereas, the largecaps will have higher benefit since they have the ability to come up with new investment plans and are immediate beneficiary of improvement in economic activities. Government has been working well to overcome the economic clampdown. But to see a faster recovery, we need to bring normality in the financial system of the country. A quicker remedy is needed regarding IL&FS issue, similar type of issues in housing finance, NPA, PSUBs and smooth working of GST system. At the same time FIIs are concerned about global slowdown due to trade-war, Brexit, geo-political issues and premium valuation in developed countries like US.
The broad economy will take some time to gain and invest in new projects due to cut in taxes and government stimulus. We can expect a slow U shape recovery since we require recovery in world export which is not visible today and also to remove the blockages in our domestic financial market. Having said that the worst for domestic economy may be over by Q2 – Q3 FY20. We can expect a faster recovery in consumption led by stability in job market, festive seasons and reduction in interest cost. This quick benefit cannot be replicated in non-consumer segment as financial sector and new investments have a lag-effect. The equity market may trade with a negative bias in the short-term. We expect the broad market to maintain its positive bias in the long-term, while 11,100 to 11,300 will hold a strong support for Nifty50 in the short-term.
Posted: October 3, 2019