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Does Rate Cuts And Tax Cuts Really Spur Growth?


Posted on 04-Oct-2019 Comments  0

Monetary Policy

Growth revival was clearly the overarching theme of the policy


The 25 bps rate cut by the Monetary Policy Committee was already factored in by the markets. However, the big overarching theme of the policy was the push to growth in a real sense.

25 bps rate cut for now

The rate cut of 25 bps was lower than what the markets had anticipated but there was a reason for the cautious approach adopted by the MPC. Rates are already at a 15-year low and room for maneuver is quite limited. Secondly, the government has already given a fiscal boost to Indian companies via the tax cuts and from that perspective, a 25 bps rate cut was par for the course. The real positive takeaway was that the stance of the policy was retained as “Accommodative” leaving room for more rate cuts if warranted by the data.

Growth the missing link

From the previous policy announcement itself, it was clear that growth was the big factor. GDP growth for the June quarter had fallen to just 5% and the RBI has projected GDP for the second quarter to grow at just 5.3%. The full year growth estimates of the RBI stand downgraded by 80 bps to 6.1%. That is something that underlines the gravity of the entire problem. We have also seen core sector growth dip into negative and the PMI services dipping below 50. For the RBI, the policy undertone has clearly been about giving the growth push.

Time for transmission

The key feature of the policy statement was that the RBI dwelt at length on the urgent need for transmission. By the RBI’s own analysis, out of the 135 bps rate cut till October 2019, the banks had only passed on 29 bps to borrowers. RBI has been quite clear that such a low rate of transmission would not work as rate cuts would not translate into lower borrowing rates and hence would not spur growth. However, the RBI has also expressed confidence that things would change rapidly. For example, banks have shifted to the external benchmark based loan pricing from October. That means; loan rates would be directly linked to repo rates or to the T-bill yield which will ensure smoother transmission to the end customers. That could be a big spur for growth in GDP.

Inflation is ambivalent

The RBI has projected inflation for the full year at a higher range of 3.2%-3.5% but has expressed confidence that it should be high enough to signify growth but low enough for more rate cuts. If inflation stays in that range then the RBI has good reason to further cut rates to support growth. While food inflation is likely to remain balanced, they are expecting fuel deflation to negate the impact of food inflation. With core inflation trending lower, the RBI does not have too many worries on the inflation front. Growth is the key!

MAT Credits

“No MAT credits” could be a hurdle for companies tax shift


During the week, an innocuous CBDT clarification disappointed markets quite a bit. CBDT clarified that companies that opt for the new 22% tax system will not be eligible for any future MAT credits or credits for accumulated depreciation. That could be a major disincentive for Indian companies to shift to the lower tax structure. First the background!

What is MAT credit all about?

Indian tax system runs on the system of minimum alternate tax (MAT). Under that system, each year companies are required to pay a bare minimum of 18.5% of MAT to the government. Quite often, such companies may be only required to pay tax at say 15%. In that excess, the excess MAT collected will be refunded to the companies. This system of MAT credit has been going on for over 20 years now. The new 22% tax bracket proposed by the government will be without any rebates / exemptions and also will not attract any MAT. But, there is an open issue here. Most large companies have MAT credits running into hundreds of crores. In addition, they also get separate credit for any accumulated depreciation that is carried forward. These helped to reduce the effective tax. MAT was nothing but an advance tax collection system. Now by refusing any MAT credit for past years, the CBDT has put the companies looking to shift their tax bracket into a quandary as no company would be willing to lose out on their past tax credits.

What are the options?

If you were to look at the CBDT circular, there are only two options that the companies have at this point of time. Firstly, they can opt to do a major shift to the new system where they pay 22% tax profits plus cess and surcharge. But that would only be helpful if the actual exemptions and MAT credits are limited. For other companies, the only option will be to delay the onset of the 22% formula till the time the past MAT credits are fully availed. Remember, the companies that continue with the old system will still have to pay MAT at a lower rate of 15%. Hence MAT credits could still accumulate. The government needs to find a way out.

Give a one time-exemption

If the largest companies in the market do not opt for the new system, its value would be substantially diluted. It will just be an improved version of the current system. Also the absence of large companies in the 22% formula dilutes its impact. The government must consider giving companies a one-time exemption on available MAT credits. Instead of allowing them to write off the credit in the first year, they can look to amortize such accumulated credits over a longer period of time. This will not hit government revenues and also convince companies that their legitimate credits will not be lost. It can do a lot of good for the shift to New Tax regime!

H2 Borrowings

Borrowing numbers for second half just don’t seem to add up 


When the government announced the Rs.145,000 crore tax  break for Indian companies, the immediate impact was on the bond yields. The argument was that the government would be resorting to more borrowings and a higher fiscal deficit. But, the government has held its second half borrowings at Rs.268,000 crore. How will the gap be bridged?

Expects slow move to 22%

The government is most likely betting that the move to 22% tax will not be en masse, but a lot more phased out. The companies that pay lower taxes today or those with MAT credits will continue with the old tax system. That should include most of the Nifty companies. Hence the impact on revenues should be much smaller. Secondly, the view of the government is that the tax loss could be largely compensated by the exemptions and rebates foregone.

Betting on tax base boost

The government has been constantly harping on the need to widen the tax base. The belief could be that this 22% tax will bring more companies under the tax bracket and compensate for the lower rates. However, that may be more of a medium term goal than a short term goal. As we have seen in the case of income tax, even when compliance improves, it does not necessarily lead to higher tax revenues. Hence revenue boost may not work in this year.

A big push to privatization

On this subject, the government has been playing its cards pretty close to its chest. But there are indications that the government may give away traditional aversion to minority shareholding in PSUs and that could be a big revenue booster. The government has already identified BPCL, CONCOR and Shipping Corporation for complete sale and privatization. That could elicit a lot of investor interest and give a big push to revenues. If the government can quickly get its act together on the subject of strategic sale, then the revenues could get a real push and compensate for the gap in revenues. This can work but will require speed and expertise in terms of planning and execution.

Some avoidable ideas too

Of course, push comes to shove; the government may be forced to adopt more short term measures. It has already asked the RBI for an interim dividend of Rs.30,000 crore but that is a temptation best avoided. It is nothing but monetization of deficit. The other alternative is to convert borrowings into off balance sheet items. This is again best avoided as the organization comes under pressure. Finally, the option of cross stake sale is always there, but that may not add much value. One thing is certain that the government has an ace up its sleeve to bridge the gap. One only hopes it is actually GDP accretive!

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