India's USD20 billion tax cut is likely to have a limited impact on corporates' and banks' financial profiles but may revive capex and demand in some sectors, says Fitch Ratings. The Indian government on 20 September 2019 introduced an option to pay a reduced corporate tax of 25.2% (including all surcharges and cess and excluding any exemptions) from 35% and a lower effective tax rate of 17% for newly set-up manufacturing companies after 1 October 2019. The minimum alternate tax (MAT), a minimum tax paid even by loss-making companies, was also cut to 15% from 18.5%. The announcement came amid a slowdown in GDP to a six-year low of 5% in the April-June 2019 quarter. Once the companies choose to move to the new tax regime, they cannot return to the previous regime.
We believe the auto, steel, cement, telecom and commodity sectors will benefit more from the tax cuts, while the information technology, power and pharmaceutical industries will benefit the least as they typically pay lower taxes because of the tax benefits from operating in special economic or export-oriented zones. The regulated electric utilities are also unlikely to benefit because they operate on a cost-plus business model and are required to pass through their entire tax expense to their customers.
We expect telcos and steel companies to use the excess cash from the tax cuts to reduce leverage, while the auto and its ancillary business, and consumer-discretionary sectors will likely use the cash to improve demand by passing on the tax cuts to consumers through product price reductions.
We believe the tax cuts may revive capex, but with a time lag as most corporates will likely wait for a demand rebound before committing to fresh capex. Most sectors including steel, autos, telcos and utilities are unlikely to immediately announce new budgets due to the tax cuts. However, the cement sector may use the cash saved for additional capex or deleveraging as their demand has not been as affected as that of the auto and property sectors.
Oil-marketing companies will likely use the tax savings to fund their ongoing high capex or higher returns to shareholders, depending on the success of the government's plan to sell its stakes in some state-owned enterprises. Some corporates also may bring forward their capex and move part of their production to the newer units with tax breaks.
Tax cuts will provide stressed corporates with some cash flow headroom; however, they are unlikely to lead to leverage reduction, which implies that banks' propensity to lend to these stressed sectors will remain low. The banking sector's struggle with a large bad-loan stock and weak capital buffers are not over yet, while recently announced mergers among banks will keep them distracted for the next few months. We believe the current economic slowdown has started manifesting in the stress faced by the SME sector, evident from the government's forbearance this month to allow banks to not recognise the SME sector's non-performing loans (NPLs) until March 2020. Should the economic slowdown persist, we believe the SME and retail sectors will likely be the most vulnerable, which could result in a fresh wave of NPLs.
Tax rates, which are now on a par with Asian peers, could lead to higher foreign investments. China, South Korea and Indonesia levy a corporate tax of around 25% while Hong Kong and Singapore have lower rates of 16%-17%. Thailand and Vietnam have corporate tax rates of around 20%. India's 17% tax cut on new capex, with no MAT, will attract fresh investments. We expect smartphone-component manufacturers to move some of their production capacity from China to India amid growing smartphone demand in India and the lower tax burden. Luxury-car makers could also move some of their car-assembly or component manufacturing units to India to take advantage of the lower taxes.
We believe the auto, steel, cement, telecom and commodity sectors will benefit more from the tax cuts, while the information technology, power and pharmaceutical industries will benefit the least as they typically pay lower taxes because of the tax benefits from operating in special economic or export-oriented zones. The regulated electric utilities are also unlikely to benefit because they operate on a cost-plus business model and are required to pass through their entire tax expense to their customers.
We expect telcos and steel companies to use the excess cash from the tax cuts to reduce leverage, while the auto and its ancillary business, and consumer-discretionary sectors will likely use the cash to improve demand by passing on the tax cuts to consumers through product price reductions.
We believe the tax cuts may revive capex, but with a time lag as most corporates will likely wait for a demand rebound before committing to fresh capex. Most sectors including steel, autos, telcos and utilities are unlikely to immediately announce new budgets due to the tax cuts. However, the cement sector may use the cash saved for additional capex or deleveraging as their demand has not been as affected as that of the auto and property sectors.
Oil-marketing companies will likely use the tax savings to fund their ongoing high capex or higher returns to shareholders, depending on the success of the government's plan to sell its stakes in some state-owned enterprises. Some corporates also may bring forward their capex and move part of their production to the newer units with tax breaks.
Tax cuts will provide stressed corporates with some cash flow headroom; however, they are unlikely to lead to leverage reduction, which implies that banks' propensity to lend to these stressed sectors will remain low. The banking sector's struggle with a large bad-loan stock and weak capital buffers are not over yet, while recently announced mergers among banks will keep them distracted for the next few months. We believe the current economic slowdown has started manifesting in the stress faced by the SME sector, evident from the government's forbearance this month to allow banks to not recognise the SME sector's non-performing loans (NPLs) until March 2020. Should the economic slowdown persist, we believe the SME and retail sectors will likely be the most vulnerable, which could result in a fresh wave of NPLs.
Tax rates, which are now on a par with Asian peers, could lead to higher foreign investments. China, South Korea and Indonesia levy a corporate tax of around 25% while Hong Kong and Singapore have lower rates of 16%-17%. Thailand and Vietnam have corporate tax rates of around 20%. India's 17% tax cut on new capex, with no MAT, will attract fresh investments. We expect smartphone-component manufacturers to move some of their production capacity from China to India amid growing smartphone demand in India and the lower tax burden. Luxury-car makers could also move some of their car-assembly or component manufacturing units to India to take advantage of the lower taxes.