GST and macroeconomic question marks

Nobody really knows what the new tax regime will do to corporate balance sheets or govt finances

Many years ago, Satish Gujral painted a famous portrait of Jawaharlal Nehru with his hands enmeshed in red tape. As the goods and services tax (GST) rolls out next week, some contemporary artist might want to update that, replacing Nehru with an image of the politician who currently occupies the same position.

India Inc is only just beginning to realise the full dimensions of the red tape the GST will entail. It is epic. Corporates operating across India will need to file literally hundreds of tax returns every year across multiple registration points. The volume of paperwork may drive small businesses into penury.

In addition to painful filing processes, the GST tax code is itself complex enough to puzzle an army of accountants. There are multiple rates, and cesses levied upon those rates, and the usual plethora of sub-clauses and sub-sub-clauses which should keep courts and accountants occupied for years. And don’t forget the infamous anti-profiteering provisions.

However, India’s current tax codes are so convoluted that even this labyrinth may be easier to negotiate. The bulls continue to invest in that hope. The GST will take many months, if not years, to settle down, however.

It is a major change in the tax system of course and nobody really knows what it will do to corporate balance sheets. For that matter, nobody knows what it will do to government finances since it will require a complete overhaul of all assumptions pertaining to revenue collections. Analysts who are attempting to make projections of FY 2017-18 earnings, and economists who are examining public finances will have to live with huge error margins and adjustments.

As of now, optimism is driving those guesstimates and many investment houses are projecting earnings per share gains of between 14 and 18 per cent across the market. Most analysts estimate that the current valuations — averaging at above PE 24 for the Nifty — can be sustained if institutional equity buying brings in $5 billion in the current fiscal. The last fiscal year (2016-17) saw over $13 billion — equivalent coming in with domestic institutions contributing around $4.6 billion. So this assumption is not unreasonable.

Apart from GST, the macroeconomic situation has a few other question marks. Inflation has dropped to new lows and is near the southern limit of the RBI’s stated band of tolerance. This is at least partly due to demonetisation having driven food prices into negative territory. Is the inflation transient? The RBI’s Monetary Policy Committee evidently thought so in the last review when it held rates. However, the latest inflation data shows even weaker inflation and the Index of Industrial Production for April is also quite weak.

Will the RBI cut policy rates soon? Consensus opinion says, yes it will, and at least one member of the MPC wants a deep cut of 50 basis points. Arguably, even if the RBI does cut, banks may not have the wherewithal to pass on the rate cuts and push out cheap credit.

That leads to another question: Can the NPA crisis be resolved quickly and with effective damage limitation? Given that close to 10 per cent of the GDP is stuck in stressed loans, the banking system is on the edge of collapse. Initiation of bankruptcy proceeding against three steel firms is a good signal. But the massive waiver of farm loans is a bad one.

Given political compulsions, with a sequence of Assembly elections coming up in 2018 and the general elections in 2019, more waivers and other populist measures are likely. The trouble is,  a waiver can be made instantly with a stroke of the pen whereas bankruptcy cases will proceed at much slower pace, even if laudable attempts are being made to speed things up and give creditors more powers.

A third question, of course, is the willingness to borrow, even if the RBI does cut rates. Credit demand has dipped to historic lows and corporates are wary of investing since they don’t perceive strong demand. Investment dipped into negative territory (2.1 per cent YOY) in Jan-Mar 2017.

Household consumption could be the major driver. The good news here is the monsoon, which appears to be behaving, and there is a historic correlation between a good monsoon and strong household consumption.

None of the data matters if investors and traders are prepared to ignore the medium term and look forward to a better future and continue investing upon that assumption. That might well depend on global growth trends and geopolitics.

The Eurozone is seeing its fastest growth in a decade. China is doing well with rising GDP forecasts. US growth trends look reasonable though the Fed is determined to tighten monetary policy. Brexit and its fallout are being negotiated as you read this, and the UK may be headed soon into yet another election. Continuing investigations of possible collusion between Donald Trump and Russian hackers during the presidential campaign of 2016 could derail the US administration.

In the short term, any concessions Modi wins from Trump in their weekend meeting could energise the market, especially the IT and pharma sectors. There’s been some selling in the recent past and technicians will be hoping that support at current levels holds.