The other side of the FM announcement

In a not so unexpected move, the finance minister Nirmala Sitharaman announced cut in corporate tax rates for domestic companies. Although the direction was on expected line, what surprised everyone was the size. The corporate tax rate has been cut to 25.17 per cent including surcharges for current 30 per cent without any surcharge. The equity market welcomed the tax cut and frontline indices increased by more than 5 per cent, one of the highest in last 10 years.

Nevertheless, there is another side to this. These measures will have an impact on the government’s revenues, deteriorating the fiscal balance. Reduction of the tax rate is likely to cost government Rs. 1.45 lakh crore. It means the government has to forego revenue of this amount. Well, this is likely to increase the fiscal deficit of the government by around 0.5 per cent and will remain within 4 per cent.

Activity in the bond market has been already reflecting the impact of this decision. The benchmark bond yields are already up by around 20 basis points, suggesting an effective rise in the benchmark rates by a same proportion.

This will make corporate borrowings costlier and will set off some of the gains due to cut in corporate tax rate cut. Moreover, it will increase the discount rate at which equities are valued and hence will moderate the valuations little bit.

In terms of mutual fund performance, it will impact positively to the equity dedicated fund, however, will impact negatively the bond dedicated fund as bond yield rises.