India Inc. was surprised with an early festival bonanza on September 20, 2019, when the finance minister, Ms Nirmala Sitharaman, delivered a major booster dose in the form of reduction in corporate tax rates.
With effect from April 1, 2019, the effective corporate tax rate, including surcharge and cess, now stands at 25%, down from 35%. For new manufacturing units that are set up after October 1, 2019, and commencing production before March 31, 2023, the effective tax rate will be lower at 17% from approximately 30% earlier. However, to avail of the benefits of lower tax rate, corporates will have to forego other incentives such as special economic zone-based exemptions and industry-specific incentives.
The move came as a big relief for the corporates in India as many of them are reeling with low earnings growth.
The tax rates are now in line with or even lower than many other Asian countries. This could give India a competitive advantage as global companies are looking for alternate locations in view of the US-China trade war. Lower tax can result in higher profits which can be utilised for debt reduction or business expansion, thus reviving the animal spirits in the industry.
Banks, FMCG, and auto and auto ancillary are expected to be the major beneficiaries of the low tax regime. Some of the major companies in these sectors such as SBI, HDFC Bank, HUL, and Maruti Suzuki pay high effective tax rate of around 30% or more at present.
Corporates may pass on the benefits of higher earnings to consumers by lowering the prices of goods and services, which to an extent can address the concern of slowdown in consumption.
In the last few weeks, the finance minister announced several measures to revive the economy, some of which are as follows:
- Withdrawal of higher surcharge on investment gains
- Angel tax relief for start-ups and their investors
- Deferment of hike in registration fee till June 2020, additional depreciation for purchase of vehicles till March 2020, and lifting of ban on purchase of vehicles by government departments to revive auto sales
- Capital infusion of Rs 70,000 crore into PSU banks for credit growth
- Liquidity support for housing finance companies increased to Rs 30,000 crore
- Merger of 21 PSU Banks into 12 to facilitate efficient use of capital
- Banks to pass on the rate cut through MCLR reduction which will benefit borrowers in the form of lower EMIs
- Permitting Aadhar-based KYC for NBFCs and domestic retail investors
- A Rs 10,000 crore special window to provide funding for housing projects
- Organisation of annual mega shopping festivals to boost exports
- Lower GST on hotel tariffs
The announcements have set the mood for a bright and upbeat Diwali for the equity markets as the prospects look positive for the medium to long term. The Sensex rose 1921 points (highest in a decade) on the day of announcement and is expected to rise more in the coming days. Following this, FPIs who recently shied away from Indian markets may make a comeback. This is a positive sign that can lift market sentiments.
If the corporate earnings grow as a result and lead to a sustained rally in equity market, mutual funds are likely to benefit from the upswing.
To benefit from the on-going rally, some investors may get carried away and go overboard while investing in the hopes of a rally in the future. On the other hand, some investors may think of booking profits and exiting the scheme. Both strategies can prove to be harmful to your financial wellbeing.
Upswings and downswings are an eternal part of equity investments and one cannot predict which way the market will move next.
Large cap stocks tend to withstand better during volatile market phases and provides stability to the investment. Sustainable business models, better competitive advantage, higher market share, and quality of management are some of the factors that make investment in large caps attractive. Some of the large-cap companies are expected to benefit significantly from the lower tax rates.
Whereas, mid cap stocks have the potential to generate higher returns, especially during a market rally. Reduction in tax rate and the resultant higher earnings may be beneficial to many of the mid cap companies. The recent correction in the mid cap space further makes the category attractive.
To diversify the risk and optimise returns, investors can invest across large cap funds, large & mid cap funds, and multi-cap funds. But remember to invest with a long-term view in mind. Always pay attention to your financial objective, risk profile, and investment horizon before making any investment decision.
The measures taken by the government will take time to be implemented and show results. Therefore, the equity markets may remain volatile in the short-term.
Make sure that your portfolio is well placed to tide over the market volatility by selecting the right scheme and adopting the `Core & Satellite’ approach to investing. This asset allocation strategy lets you focus on the stable schemes with a long-term view, while at the same time capitalise on short-term opportunities.
This article first appeared on PersonalFN here.