A cut too far?
A cut too far?
India's prime minister, Narendra Modi, has been under pressure after his unexpectedly big election win earlier this year. First elected on a pro-growth aspirational platform, his popularity dwindled as rural unemployment rose and median incomes stagnated. He has now reacted: last week Mr Modi announced a reduction in the base corporate tax rate from 30% to 22%, with a further discount to 15% for new manufacturing firms. Opinion has been divided on whether this is good news for the economy, with some commentators in India more positive than others. In part this is because the Indian media is less inclined to criticise the government than it has been in the past, but also because outsiders—in my view—worry too much about India’s external debt. The fiscal deficit is slightly high. However, at around 3.7% this year, it is comfortably below GDP growth of 5.2%, based on our EIU projections, and so the debt-to-GDP ratio won’t rise. Furthermore, only a tiny share of the debt is denominated in foreign currency, and so the risk of a crisis is low (crowding-out of private investment and inefficient spending are more concerning). The current-account deficit is more likely to be a source of problems. However, the corporate tax rate reduction should actually help if it brings in more foreign direct investment (FDI)—even at the margin—as that is a more stable source of external financing than pure financial flows.
It is true that tax cuts are not what firms in India really want—they’d prefer less corruption, less cumbersome bureaucracy, and an easier land-purchasing process. Other countries in Asia, too, are trying to attract firms wary of China due to the trade war: Malaysia has streamlined FDI approvals and Taiwan has a range of financial incentives. The extra discount for new manufacturing firms, therefore, is more to retain rather than enhance competitiveness. Nonetheless, I think that on balance it is a good move, and I expect to see investment in India pick up in 2020-21 as a result.
What do you think?