DBS Bank expects modest rate cut at RBI's MPC meeting in October

The new effective rate takes India closer to its regional peers, on par with China, South Korea, Indonesia and OECD average

The Reserve Bank of India's Monetary Policy Committee will go for a modest rate cut at the October meeting following the corporate tax rate cut announced by the government, Singapore's DBS Bank has said.

"With this fiscal boost focused on investment revival and not consumption (hence not inflationary), we reckon that the RBI MPC might proceed with a modest cut at the October MPC," the bank's economist Radhika Rao wrote in commentary on the Indian economy on Monday.

"(RBI) Governor Shaktikanta Das also reinforced his dovish bias due to weak inflation and negative output gap," Rao noted in the report on the Indian government's corporate tax rate cuts.

The central bank is likely to watch these developments closely as risk-free rates rise, Rao said, adding that the equity markets surged on Friday, while risk-free yields ticked up.

On September 20, Finance Minister Nirmala Sitharaman announced to cut the basic corporate tax rate for domestic companies to 22 per cent from 30 per cent. The effective tax rate for domestic companies was reduced to 25.17 per cent from 34.94 per cent inclusive of surcharge and cess.

Also, new manufacturing companies starting production on or before March 31, 2023 and incorporated on or after October 1, 2019 will have an option to pay tax at a lower rate of 15 per cent if they do not avail any exemption/incentive.

The effective tax rate for such companies will be 17.01 per cent, inclusive of surcharge and cess.

The new effective rate takes India closer to its regional peers, on par with China, South Korea, Indonesia (announced an upcoming cut to 20 per cent) and OECD average, the report said.

These changes come as a positive surprise and are intended at breaking the cycle of weak sentiments and subdued economic activity.

"Concomitantly, we are mindful that the government will also make some savings on the exemptions that companies were previously availing of and henceforth will have to scale back, if they wish to enjoy lower tax rates. We assume here that these savings have been accounted for in the fiscal cost estimate provided by the finance ministry," said Rao.

The government will require to scale back expenditure in the second half of the year to keep the overall deficit near 3.5-3.6 per cent of GDP, the report said.