India surprised the markets Friday with a broad corporate tax cut, with Indian equity markets rallying more than 5% and many more domestically focused companies rallying by as much as 10% on this news. We have had a positive long-term view on India for many years now, due in part to favorable demographics, increasingly pro-business government, and significant opportunities for productivity improvements. Despite this favorable backdrop, it has been a very bifurcated market. Quality banks and consumer companies have outperformed, but the underperformance of lower-quality banks, utilities, materials, and industrial sectors have resulted in the broader Indian equity market only slightly outperforming the broader emerging market equity benchmarks over the past five years. This has partly been due to reforms being implemented at a slower pace than anticipated and we have yet to see the acceleration in capex investment and foreign direct investment (FDI) we have expected.
The key question our team is debating today is whether or not last night’s announcements are finally the catalyst India needs to unlock a capex and FDI investment cycle. In our opinion, one of the most interesting component of Friday’s news was the reduction of the new domestic manufacturing tax rate to 15%—making it one of the lowest throughout Asia. The Indian economy may already be at the later stages of its bottoming cycle with industrial utilizations increasing above 76% during 4QFY19, but these tax cuts appear to target the disruption in supply chains we are seeing throughout Asia as a result of the US-China Trade War. Despite a very young and large workforce, India has historically failed to attract the manufacturing capacity and prowess China has enjoyed, likely due to more regulations and higher tax rates. In recent years, India has implemented several reforms to improve the ease of doing business in India and Friday’s tax cut would seem to be another step in this direction.
Most discussions around potential winners from the movement of the Global Supply Chain out of China have focused on ASEAN countries like Vietnam, Taiwan, Thailand and Malaysia, but we may have underestimated India’s potential to benefit from these developments. At this point, it is too early to know for sure. We’ll await more concrete signs that companies are actually moving production into India. In the interim, the India economy seems poised to benefit from a stabilizing liquidity environment, higher-utilization rates leading to a resumption of the capex investment cycle, and now fiscal stimulus that has the potential to both stoke domestic demand as well as attract additional foreign investment flows. Initial estimates are that Friday’s tax cuts could increase profits for the broader India index by more than 10% in 2020, which indicates to us that last night’s 5% move was not an overreaction. In fact, if these tax cuts result in a few of the improvements we have highlighted, there could be significantly more upside in Indian equities.
Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. The views and strategies described may not be suitable for all investors. References to specific companies, securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to buy or sell. The above commentary for informational and educational purposes only and shouldn’t be considered investment advice.
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