Market View

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Ravi Gopalakrishnan, Head of Equity, Principal Mutual Funds

On September 20, the government announced sharp tax cuts to 25% for all corporates and to 17% for those who set up new companies in the manufacturing space.  Surcharge on capital gains on equity was also done away with. This is an important structural reform undertaken by the Government. The tax cuts should help in reviving sentiment among domestic companies. However, the immediate impact of the tax cuts on reviving economic growth would be muted as currently the demand side of the economy is the concern, and these cuts help the supply side of the economy. Their near term impact on economic growth would depend on the extent to which the corporates share the gains with customers by cutting prices, use the surplus to make investments or conserve these instead. These tax cuts provide a fiscal support to the economy and complement the aggressive monetary stimulus which the RBI has undertaken to spur economic growth.

The fiscal deficit target of 3.3% of GDP seems likely to be breached, given the weaker than targeted GST collections and impact of these tax cuts. While the government is rightly focused on improving growth in the economy, it should be also be cautious to not let the fiscal deficit get out of hand. The government has also been pushing the Public Sector Enterprises to improve on their capex spending, which can help kick start the economic activity over the next few quarters. The Government is also seeking to aggressively implement the PSU disinvestment program which would, to some extent, cushion the negative impact of the tax cuts on fiscal health.

After the tax cuts, Indian tax rates are in line with most countries in Asia-Pacific. This could lead to global companies considering India as one of the investment destinations if they were looking to diversify manufacturing out of China. The lower tax rate for manufacturing companies set up after October 1, 2019 is targeted at global companies seeking to diversify and de-risk their global manufacturing and supply chains given the uncertainty created by the ongoing trade dispute between the United States and China. India, is well placed to seize this opportunity and attract significant share of FDI in manufacturing, which will help the country achieve the target of US $ 5 trn by 2024.

The markets over the past few quarters have been declining on the back of several factors both domestic and international. Slowdown in manufacturing – most visible in the automobile sector, continuing stress in the NBFC sector, the trade war between the US and China etc. Select companies have continued to do well despite the overall volatility in the equity markets. The corporate tax cuts and the direct impact on earnings of this move would provide potential investment opportunities in the markets. There would always be stock picking opportunities in such markets, and we continue to pursue these ideas and opportunities.

The slowing economic growth in recent quarters has resulted in single digit earnings growth for most major companies. However, only a select group of large companies have managed to provide decent revenue and earnings growth making the market extremely polarised. We believe, as the economy recovers, the recovery would be more broad based and the mid cap and small cap companies would also participate in the recovery of economic growth. This would provide investment opportunities in the mid cap space also.

The Mid and Small Cap segments of the markets have seen a lot of volatility in the last few quarters. The Mid Cap Indices are trading at 2-year lows. We have seen a significant correction in the mid cap segment – both in terms of price and time.  Further, the valuation premium that the mid cap index enjoyed vis-à-vis the large cap indices has turned to a discount currently. Select stocks in these segments are providing attractive investment opportunities. The lower tax rates for manufacturing units set up after October 1, 20019 would also help companies in the mid and small cap space. Since Contract manufacturing would also benefit from the lower rates, this is a significant structural positive for companies in the mid cap segment.

Investors should allocate a portion of their equity investments into mid and small cap funds based on their risk appetite as well as investment horizon. It is advisable to invest in equity funds through STPs and / or SIPs.

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