How govt growth push has altered landscape in equity & debt assets
Low inflation still continues to provide cushion for rate cut, albeit in a more staggered manner.
These measures have created an air of optimism in the market as lower tax means money saved for years together. The tax cut will lead to a cash retention of around Rs 1.45 lakh crore with the corporate sector, which will in turn become the risk capital available with companies.
Companies may utilise this retained cash for lowering prices, future capex investment and expansion, debt de-leveraging or dividends/buybacks.
On one hand, this will create credit demand for banks. On the other hand, it may lead to reduced NPA stress and put money in hands of customers/investors. To compound that with PSU bank recapitalisation, the banks will find themselves in an advantageous position after a long time.
The strongest pitch that India has made for FDI in a while is the special 17 per cent rate for new manufacturing companies. This measure has brought the tax rate lower than most countries in the ASEAN region and will augur well for companies moving away from China.
For any foreign manufacturer, now to ignore a country like India that has a 1.3 bn market size, one of the cheapest labour costs and a very competitive tax rate, would be difficult to justify to its board. There are many industries that are doing research and development in India for various global companies.
Many Indian corporates are also now willing to put the money saved on tax into R&D. India spends only about $60 billion on R&D while China spends about $400-500 billion. Therefore, there is scope for further increase in the pace of investment. This move may help in that.
Kudos to the government for bringing in these. However, it must not stop at that. Now that India has wrest the initiative, we must build on the momentum. The availability of land, access to market, and supportive labour laws are business efficiency and viability issues.
The government must help reduce these barriers for investors. And it is our studied understanding that government is aware of these issues and may look to address the same in the future.
On the other side, there is this concern that the forgone revenue receipt by the government may lead to fiscal pressure. After the new corporate rates, the expected fiscal deficit is likely to be around 3.7 per cent. We do believe that the growth boost from this measure may lead to greater tax revenue over the long term.
More steps will be required for PE rerating. Since we have increased tax rebate to corporate India, there is a gap on the fiscal side that needs to be bridged. If it is bridged through asset divestment i.e. strategic divestment and not market divestment, then the market will get rerated. Moreover, if we bridge the gap on borrowing side by sovereign bond issue or by attractive FPI capital into the Indian bond market, then certainly market will get rerated.
In the short term though, expectation of fiscal pressure has caused some spike in yield. The yields may remain relatively high until it becomes clear as to how the government aims to mitigate the potential rise in fiscal deficit. However, we believe that the companies will now have a better interest coverage ratio and debt servicing capability.
Thus, the spreads of high quality corporates may in fact come down over a period of time. Moreover, low inflation still continues to provide cushion for rate cut, albeit in a more staggered manner.
Thus, the tax rebate is a step in the right direction. It has changed the sentiment significantly and opened many more possibilities for rapid growth. However, we need to support it by some more innovative steps such as strategic divestment, sovereign bond issue or inclusion on India in the bond index, which attracts more permanent FPI capital in the debt market.
We had pointed out earlier in our monthly con-call that the market is likely to bounce back once the government comes out with a stimulus package. While the market runup was steep and quick; we believe the market still remains around the fair-value zone. There is still buying opportunity in the market due to panic selling that had happened earlier, especially in the midcap and smallcap segment.
For this reason, we believe that a staggered approach to investment in midcaps/smallcaps and in large and midcap category fund is a lucrative option. Lump-sum investors can look at investing through balanced advantage fund with follow-on STP flowing into one of the above equity funds.
Fixed income investors can look to invest in credit fund and short-term bond funds. Dynamic bond fund may also be a lucrative bet if yield spikes significantly from current levels. In a nutshell, the India story is coming back on track. The next few months will be critical as to how we compete in the global arena to attract foreign capital and trade incentives in our favour.
The political dispensation is clearly at it. India’s vast strength, influential diaspora, and cultural goodwill must be mobilised to fulfil the very achievable $5 trillion dream.