Amid slowing economic growth in India, the Modi government’s surprise corporate tax cuts have come at an opportune time, according to Franklin Templeton Emerging Markets Equity’s Sukumar Rajah. He explains why the fiscal adjustment could improve India’s competitiveness among its regional peers.

India’s proposed corporate tax cut, which slashes the basic rate to 22% from 30% for domestic companies, is a welcome surprise.

The meaningful reduction in corporate rates sends a strong signal to investors that the Indian government recognizes the need to improve India’s economic growth and boost the corporate sector’s competitiveness.

This fiscal change comes at a time where India’s annualized gross domestic product (GDP) growth is slowing. In the second quarter of 2019, GDP grew by just 5%, marking the fifth consecutive quarter of declining growth.1 India’s growth fell behind that of China, which grew 6% in the second quarter.2

In the immediate aftermath of the tax announcement on September 20, India’s equity market reacted positively to the news, while the Indian rupee rallied. We’d also expect earnings to improve in the short term. However, bond markets declined on fears that the Indian government may now have to borrow more to meet the additional expenditure.

From a macro perspective, the proposed stimulus might not cost the government as much as it is made out to be. It’s estimated tax cuts could cost the government around US$20 billion. Though companies who want to take advantage of the new tax rate would not be eligible for other exemptions. We think the net figure of tax revenue foregone is more likely to be close to US$10 billion.

Improving India’s Competitiveness

In our view, corporate tax cuts should likely help boost capital expenditure and attract foreign investments to India. India’s corporate tax rate is now on par with its regional peers that have manufacturing hubs, such as Cambodia, Taiwan, Thailand and Vietnam. And, India’s corporate tax rate is now more competitive than China’s 25% rate.

New, lower corporate tax rates also included new manufacturing companies. Businesses that start operations between October 2019 and March 2023 would be eligible to apply for a 15% corporate income tax rate. This ties in with Prime Minister Narendra Modi’s “Make in India” initiative.