Tax cuts in India: Damn the torpedoes

Other countries should take notes on the fiscal pump priming in India. Will it blow up the federal budget or save slowing growth?

From an economic policymaking standpoint, you have to hand it to the Narendra Modi-led government of India. When you think everything has been said and done on a particular matter, they find a way to surprise you. Unfortunately, at times, that has led to missteps like demonetization. For a change, though, the government made a brilliant move, in my opinion, by fiscal pump priming the economy with a corporate tax cut. While this measure is not without significant risks, I believe it is a step in the right direction.

The Indian government recently announced a set of policies to substantially cut corporate taxes and provide new incentives to encourage capital spending. In addition, the government undid a lot of recently promulgated surcharges on long-and short-term capital gains for investors. Again, this move is designed to encourage economic risk-taking.

While the fiscal consequences of this move are considerable — because it will propel the already bloated budget deficit into even more perilous territory — I believe these measures are still an important and necessary step.

A higher economic growth rate is much needed

Over the past few years, a series of policy measures such as demonetization and the rushed implementation of the goods and services tax have cast a pall over the growth outlook. Making matters worse, India faces a global economic slowdown and a local liquidity crunch. India’s economy, once one of the fastest-growing economies in the world, has, in more recent years, slowed precipitously. While the absolute growth rate is still 5% (a high number by global standards), that level of economic expansion is still too low for a country that needs to grow very fast to provide jobs for the millions of new entrants into its labor force on a yearly basis.1

As a result of this tax cut, government spending in India is likely to accelerate meaningfully, providing a boost to both fiscal year 2020 and 2021 growth outlooks. If the Reserve Bank of India plays along by cutting rates, as I expect it will, the growth outlook will be significantly better. If nothing else, the government’s initiatives have short-circuited the negative feedback loop that was taking hold of the economy and pointing to a severe slowdown over the next 12 months.

To be sure, there are significant risks with the tax cut — the Indian fiscal deficit is one of the world’s widest, and it is probably getting wider. But in an environment where both global and domestic inflationary pressures are nonexistent, that risk, in my view, is worth taking. Furthermore, unlike similar moves in developed countries like the US, the tax incentives for companies are unlikely to be saved and instead will likely restart growth in capital spending.

Bond markets’ concern may be a price worth paying

The bond markets, for one, may not like the tax cut much, but again, that may be a price worth paying because the consequences of doing nothing, which seemed to be the stance of policymakers since the elections, were quite severe. Despite the fears of a potential credit downgrade due to a widening deficit, I believe the government’s current policy moves will help, rather than hurt, the Indian economy.

In fact, the Modi government is showing a potential path forward for politicians in countries such as Germany. The slowdown in the global economy is the biggest risk facing the world at the moment, in my opinion. And, decisive fiscal policy initiatives, in conjunction with monetary accommodation, is what is needed. But will the politicians and policymakers in other countries take heed?


1 Source: Bloomberg, L.P. as of June 30, 2019

Important Information

Blog header image: Manjunath Kiran / AFP / GETTY

The opinions expressed are those of the author as of October 1, 2019, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

Krishna Memani serves as the Vice Chairman of Investments for Invesco. In 2009, Mr. Memani joined OppenheimerFunds, which became part of Invesco in 2019. Before he joined OppenheimerFunds, he was a managing director at Deutsche Bank, heading US and European credit analysis. Earlier, he headed global credit research at Credit Suisse; was in charge of high grade and high yield portfolios at Putnam Investments; and was a credit analyst at Morgan Stanley.

More in Market & Economic
News versus noise: Assessing the market impact of three major headlines

One of the key themes I have been discussing in the last several years is geopolitical disruption — and we got a heavy dose of...