FM's tax cuts may give more elbow room to govt to sign the RCEP deal

Key pain point of Indian industry, of being a high-cost producer of goods, substantially reduced; Indian tax on companies now slightly below average Asian level

Friday’s tax cuts could give the government more space to look to sign the Regional Comprehensive Economic Partnership (RCEP) deal between 16 Asian nations, including India. Finance minister Nirmala Sitharaman has substantially reduced one of the pain points of Indian industry, that of being a high-cost producer of goods. The reduction of corporation tax rates to a competitive pan-Asian level—a KPMG data set shows the Indian tax on companies is now slightly below the average Asian level—means high capital costs are not a very significant phenomena for the Indian economy going ahead. The aggregate corporation tax rates are now lower than China, Japan, South Korean and Malaysia, a no mean achievement. It has implications for the signing of the RCEP trade deal expected in November, this year. 

Going into the negotiations, Indian companies had complained that they were not as competitive as the Asian countries. One of the reasons for the non-competitiveness, they had argued, was the high cost of operations including capital and labour. They had a point. RBI data shows for the past fourteen years, the best lending rates for industry has never dipped below 8 per cent till 2018-19. Since the introduction of MCLR, the rates have only climbed upwards to 8.65 per cent in the current financial year. 

Now with the government cutting the tax rates vigorously and RBI expected to keep following suit, this crib might not be an operative constraint, soon. Of course, industry still has to factor in the sunk cost of past investments as those will not get the benefit of the tax breaks. But for future investments, it should be a different story. Since employment of labour has not been a strong suit for Indian industry, growing at just 2.72 per cent in this decade, it should be presumed that when they argue about high factor costs they principally mean the high cost of capital. As the data from the Annual Survey of Industries show invested capital including both fixed and working capital for Indian industry has risen cumulatively by 10.24 per cent between 2010-11 and 2016-17. The share of wages to workers as a percentage of capital employed has remained below 4 per cent in this period even though it has grown at above 12 per cent since the base has been very low.  As a Grant Thornton note pointed out "the government has addressed the key demand of businesses to align India’s corporate tax rate with the current economic reality where most large economies like the USA and the UK have taken similar measures to attract capital and investments".

Sure, there are other factors like export documentation, turn around time at ports and collection efficiency of tax refunds that also impact industry’s ability to compete abroad. But the tax cuts have certainly dented a key reason for industry to oppose the trade deals.