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India corporate tax cut may boost earnings, but unlikely to spur consumer demand

Companies must lower prices, launch new products to woo buyers

Hindustan Unilever, India's largest consumer goods maker, could see as much as 7% jump in earnings thanks to the tax cut.   © Reuters

MUMBAI (NewsRise) -- India's surprise move to cut corporate taxes to among the lowest in Asia may boost the profits of banks, automakers, and consumer goods companies, but the measure may not be enough to revive the sagging demand in Asia's third-largest economy.

On Friday, Prime Minister Narendra Modi's government cut the corporate tax to 22% from 30% as part of efforts to turbocharge the economy that has slipped into a slow lane in recent months, triggering factory closures and job cuts. The move sent the country's benchmark stock index surging, marking its biggest intraday gain in more than a decade. The index sustained the gains on Monday, with the S&P BSE Sensex gaining another 2.8% amid widespread upgrades in earnings estimates by brokerages.

India's gross domestic product had expanded at the slowest pace in almost six years between April and June as the industry grappled with tighter liquidity conditions at banks that sapped the availability of credit. The persisting weak demand has pushed automakers such as Maruti Suzuki India to slash production and cut thousands of jobs.

The tax cuts are set to increase the earnings of Nifty index companies by 8% to 10%, though the stimulus may not be enough to fire up demand, say analysts.

India's consumer goods industry is likely to spread out the benefits over two to three years through higher investment, CLSA said in a report on Monday. However, "the move may not drive up demand instantly, and the onus is on the industry to make efforts through smart price changes, higher ad spending, and focus on new launches," it said.

Shares of top Indian consumer goods companies Hindustan Unilever and Nestle India surged as much as 6.7% and 5.9% hitting 52-week highs on Monday. The shares later pared the gains to close up 3.3% and 1.2%, respectively. Hindustan Unilever, India's largest consumer goods maker, could see as much as 7% jump in earnings thanks to the tax cut.

For the automakers, lower taxes may lead to earnings rising by 10% to 12%. But analysts remain cautious amid fears of persisting weak demand and regulatory headwinds.

"The tax relief is unlikely to impart much impetus on auto demand," CLSA said. "The potential improvement in liquidity could be a slight positive for demand. However, the tax cut offers limited headroom for manufacturers to cut vehicle prices, while the benefits of increased investment and job creation will take time to fructify."

Top automakers have already warned of limited scope for a price cut post the tax reduction, saying they have already passed on significant price cuts as festival discounts.

"Most auto companies, including Mahindra and Mahindra have already given a fairly significant increase in incentive for the festive season, from 3% to 7%," Pawan Goenka, the managing director of M&M, told CNBC TV18. "So I don't think there is any room for any further passing on of the tax benefit."

Meanwhile, the shares of top Indian software exporters and drug makers slumped with limited earnings gains from the tax cut.

Shares of Tata Consultancy Services lost 2.5% in Mumbai trading, while Infosys closed down 5%, its biggest single-day fall in two years. Smaller rival Wipro ended 2.3% lower. The shares of Sun Pharmaceutical Industries and Dr. Reddy's Laboratories too slipped 1.3% and 1.6%, respectively.

--Dhanya Ann Thoppil

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