Corporate tax rate cut will boost investment

Jayshree Sengupta
Senior fellow, Observer Research Foundation

The recent gyrations of the rupee against the dollar since the rise in geopolitical tensions in the Middle East are not surprising. India is an important importer of crude oil, importing 83 per cent of its oil needs. International prices of crude have shot up by six per cent due to the drone attacks on Saudi oil infrastructure. As a result, the petrol and diesel prices in India have surged in the past few days. 

This sudden price rise will have a cascading effect and stoke inflation. If inflation continues to rise, the Reserve Bank of India (RBI) will have to raise interest rates, reversing its current policy stance of interest rate cuts. Raising interest rates will be a dampener for new investment. To prevent the economy from further decline, a strong stimulus in the form of a corporate tax cut for all domestic companies from 34.9 per cent to 22 per cent (without exemptions and incentives) has been announced by the Finance Minister. It is likely to increase liquidity of companies and encourage new investment. The tax cut led to a surge in the Sensex and the rupee also rose by 40 paise against the dollar to Rs 70.94.

The rupee has depreciated 3.9 per cent against the dollar in recent weeks. A depreciated rupee may be good for the economy because it will boost exports, especially when they have fallen by 6 per cent in August. India’s exports will be cheaper in dollar terms, offering competition to Chinese exports in the international markets. Bangladesh and Vietnam have been able to capture the gap left by China’s decline in trade with the US because of their competitive prices. With a cut in corporate taxes and a depreciated rupee, India may be able to boost its competitiveness. India's huge export of refined oil products will also surge, though input costs of crude will be higher. 

The real reason for the rupee’s fall against the dollar, however, has been the flight of foreign portfolio investors (FPIs) from the Indian stock market. They have withdrawn $4.8 billion since the end of July, selling equity shares, which may be indicative of their solid faith in the strong dollar and investments in the US looking more attractive as compared to India where the GDP growth has sunk to a six-year low.

FPIs are forever looking for highest returns for their funds and keep moving their money from country to country. When the economic scene of a country turns gloomy and there are signs of a slowdown — falling profits and low returns on investments — they make a beeline for the exit. 

Foreign direct investment is also affected by the volatility in the rupee’s value. Investors seek a stable currency because when repatriating profits, a depreciated currency means lesser amount of profits in dollar terms.  With a cut in corporate tax, they may feel encouraged to enter the Indian market more than before. A depreciating rupee, on the other hand, is a deterrent.

The Chinese yuan too has fallen in dollar terms by eight per cent recently, especially after the trade dispute between US and China. High tariffs have made Chinese goods uncompetitive in the US market. To retain the competitive edge, the Chinese Government has allowed the yuan to slide

against the dollar, breaching the seven yuan to a dollar parity maintained over last seven years. Chinese exports will now have the advantage of being cheaper in dollar terms. India is watching China’s yuan closely and does not want to fall behind it in the depreciation game. India also does not want China to gain a competitive edge in our markets, which it already has done in a variety of cheaper end products.

The immediate advantage of the rupee’s depreciation will be felt by those receiving remittances from abroad. India receives one of the biggest remittances in the world — $80 billion — from its huge diaspora abroad. The amounts received by individuals will now be more than before in rupee terms when the rupee has sunk to the level of Rs 71-72 to a dollar. It will help boost consumption by receivers of remittances which will be good for our consumer goods and the real estate sector. Indian remittances have traditionally gone into consumption and today it is consumption that is slackening. NRIs have also been showing interest in acquiring real estate in India recently.

The IT service sector has much to gain from the rupee's fall and the recent corporate tax rate cut. India could become a hub of ICT (information and communication technology) services. Similarly, the pharma and chemicals sectors will also get a leg-up. Such new investment units will be charged 15 per cent corporate tax and this move will attract foreign firms manufacturing electronics and telecom equipment.

On the downside, there are many worries with a depreciating rupee like interest payments to service external debts by corporates. Indian companies have borrowed from abroad under External Commercial Borrowing allowed by the government to corporates to finance business as interest rates have been low for many years in the EU and US as compared to India. The external commercial debt of India’s corporates is at $41 billion (2018-19). The increase in interest payments due to the rupee's depreciation will impact their already thin profit margins and lower their productivity growth and the rate of return on investments. 

India also imports many raw materials and intermediate goods that go into export production. The gems and jewellery business is dependent on imports of raw semi-precious stones, pearls and diamonds. These imports will cost more and the gems and jewellery business will receive a setback. Already it has been ailing because of the fall in global demand and high gold prices. 

Needless to say, foreign travel by Indians will cost more. All imported items of consumption will cost more.  For those who have children studying abroad, more money will be required to finance their studies. Servicing student loans for studies will become more expensive. In other words, there will be many disadvantages for the common person if the rupee falls further.

The government has forex reserves of around $400 billion. It can easily intervene in the forex markets by selling dollars which would increase their supply and arrest the rupee’s slide. But it may not choose to intervene too much because a weaker rupee and lower corporate tax rate may have their own advantages in the present scenario.