ET Markets Roundtable: How GST can transform India

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A special session of ET Markets Roundtable saw six experts laud GST as a gamechanger, but many were sceptical about implementation from April 2017.

 

A gamechanger or a millstone? Will GST propel India to a new era of high growth or will it suffocate ease of doing business through cumbersome rules? A special session of ET Markets Roundtable saw six experts laud GST as a gamechanger but many were sceptical about implementation from April 2017. The Govt should do more to clarify the rules and bring the industry on board

Neelkanth Mishra
India Equity Strategist, Credit Suisse

I think April ’19 is most likely.” The big effort has to come in mapping the current categories like the 98 chapters of excise, the massive variation from the state value added taxes etc into five tax categories. The states and the industry have to realise that rates once set cannot be changed without Parliament’s approval. Under GST, all changes will have to be approved by the Parliament.

“Most states have rejected Arvind Subramanian’s recommendations and the notion of revenue neutrality. You have no idea how many rates are going to be there? There should be five categories, but the GST council may think differently. Will they set rates once in three years? How does it impact the fiscal freedom of the states and the budget making process?”

This is the first time that the Centre is willing to share power with the states. It cannot do anything on its own. It has to get 20 out of the 31 states to support its stance.

“If you think about services right now its central jurisdiction so there is no complexity. Say, you are doing your advertising activity in UP which your headquarters in Mumbai is coordinating. In the new scheme, your advertising promotion is happening in UP, and it has been designed by people here and you are paying an agency here. But UP will say I need the service tax… Who has thought through this? No one.”

This is going to be a very intense exercise. Building a consensus is tough, especially where a Pondicherry or Arunachal or Manipur have equal voting power as some of the larger states. Once you get into GST council and you are talking about the nitty-gritty of tax revenues, then party affiliations and all of that will take a back seat.

I don’t even think the government is prepared.

Formal credit penetration is still small and that’s because lending against cash flows is less common than lending against collateral.

In a formal GST system, where billions of invoices are generated, many small enterprises could secure formal credit. Informal sector will not shrink, it will modernise, get access to credit. Indian markets are expensive on a historical basis but not on a relative basis.

For the next two to three months, I don’t expect there to be any positive catalysts (for a rally). Economic trajectory within India is not going to be that good.

Global stress points are still very visible. For instance, wages in China are slowing as the pace of growth has started to slow.

In an economy where you have shrinking force and wage growth starts to slow than its not generally good sign. If you don’t have 17-18 per cent earnings growth for three years and the economy does not recover, markets don’t have an upwards catalyst.

We should see some meaningful acceleration from November December onwards but what could also happen is that food inflation could come down giving room for RBI to cut rates by 50-75 bps.

If yields come down to about 6.5 per cent, that will put us in a different orbit. Inflation should not be that much of a problem if GST rates are designed appropriately. We should worry about stickiness of inflation and if it wears off after base effect like it happened in other countries then it should not worry us.

Bharat Iyer
Head of India Research, JP Morgan India

Inflation tends to rise when GST is implemented and that’s been the international experience. You have large pockets of the economy which are unorganised sector and they get captured into the tax net so that is one driver of inflation.

Two, we have an economy where services tend to dominate and GST on services will be potentially higher than now and that is going to be another pocket in terms of raising inflation. Third, some articles are outside the purview of taxation right now which will also get added.

So, I wouldn’t rule out inflation ticking up marginally as this is being implemented. The government may have to err on side of caution on revenue-neutral rate due to fiscal compulsions. They may have to be conservative on rates and become lenient down the line as collections improve.

We are on the cusp of a recovery in the earnings cycle. We will get 12-14 per cent earnings growth this year and upwards of 15 per cent next year. On valuations, there is lot of focus on PE multiple of the market, that it trades at 18x versus 15x historical comparative, but the risk-free rate is low and that needs to be factored into earnings.

Two other factors are here. One, you will always have higher multiples at the bottom of the cycle, that’s the classical way you trade markets — very low multiples at the peak of the cycle and very high multiples at the bottom of the earnings cycle.

Lastly, if you look at market valuations on a priceto-book basis in terms of asset valuation, we are at 3, compared to the last two years’ mean of 3.3. Economy utilisation levels are 70 per cent, so there is lot of leverage to be harvested if volume recovery happens. The key assumption the bulls are making, which includes me, is volume recovery.

If that happens, one year down the line, we could still see the markets at meaningfully higher levels. The risk factor to this market is not micro, but macro. If oil rises beyond $60-65 per barrel, it is going to cramp us for fiscal room and affect inflation. Second is what happens if inflation rises in U (curve). Policy makers will find they are behind the curve and will have to hike faster than expected.

Global liquidity goes for a toss. Even if you look at the last three years, the street starts with 18-20 per cent earnings growth and ends at 4 per cent. What has it done to market? Nothing. We need to appreciate that the market has been driven by other factors, and we need to be bearish if those factors are reversing.

Uday Pimprikar
Partner, Tax & Regulatory Services, Ernst & Young

The quantum of work the government has to do is quite significant. Large parts in the government, at least on the face of it, are significantly under-estimating it. There is so much history, knowledge and activity that’s gone because it’s a history of 50-60 years these rates coming into being and you can’t be insensitive about it.

The second is that the rate changes that have been recommended are quite radical if you look at it on an overall basis. The merit rate is 12 per cent vis-a-vis a 0 per cent or the exempt rate. The delta is significant.

Yes, the delta between the merit and the standard rate as recommended is not as much. The entire change in management is massive and even if one does peripheral activity of it – training people, getting the entire administration in place, getting the rules out of that and so on – getting two bodies of officials work together is not an easy task.

If I look at the present officials within the central government itself, getting two teams to work together, understand the complexities and the level of education right now is fairly wanting. There is no institutional setup in the government for engagement with the industry at all, and have very peripheral kind of people at the central side that you can meet but none of these people can take decisions.

People are listening, I need to give them credit that the intentions are right. The intention is to get the law which will be easy to administer. But by now, I mean as on date the draft law has a distinct element that its been created and developed by people primarily anxious about saving revenue rather than clear policy making and that balance needs to be brought in.

The overall impact on margins are dependent on market pricing. That is one element which, from a legal side, is getting introduced and there is already talk of that and it is being done in Malaysia – anti-profiteering laws. Those are fairly ambiguous animals to deal with. Something of that kind was when China introduced and expanded the VAT some months back. But I think some bit of that kind of legislation will also creep in wherein you will need to justify if you need to retain some of the margins – why are you doing it? Is it abnormal? Some legislation like that will come into being. If a Malaysia can do that, I think we will possibly do it.

S Naren
Executive Director, ICICI Prudential AMC

You have to look at it from a global perspective. In most countries, structural reform has become a problem and every country says that it will do structural reforms but they have not been able to implement it.

GST shows that this is a government which can move towards structural reforms and that is why given a world where there is no growth, no structural reform, people are happy to see a country with growth and an intention to do structural reforms.

Something even as simple as the way oil subsidies have been handled over the last one to two years is also for us a structural reform as much as GST. That part of it creates a euphoric feeling, more than GST per se.

If you look at the rally this year, the inflow or the quantum of money that has come to India is lower than what has gone to Taiwan or Korea. It is a global equity rally and not India specific. Within India, some sectors could have gained due to GST, but the rally is not about GST. If you look at the indices globally, half of them are trading at record highs.

Another way is to look at things in context of global interest rates. What is the return expected on fixed income, globally? If most debt in developed markets is trading at negative rates, what is your base return expectation from equities? When we studied, we never imagined we will see negative interest rates and people will buy fixed income for appreciation and equities for yield.

There is a massive economic experiment happening in the developed world but not in India. You have a world where returns can’t go up but equity valuations can go up. In India, the economic cycle is likely to improve and it is too early to say you have to take out money.

I don’t think valuations are scary. From an India perspective, we look at political stability — which is there, current account deficit — which is comfortable, and growth — which is far better than most parts. We know India could outperform even on declines.

In fact, India has become a low beta market because of these three reasons. Don’t worry about disappointing valuations at the bottom of the cycle. At the top of the cycle, valuations will not disappoint. That is the time to worry. We are not at the top of the economic cycle.

Sanjeev Prasad
Senior Executive Director, Kotak Institutional Equities

The bigger takeaway from the passage of the GST constitutional amendment bill in the Lok Sabha and the Rajya Sabha is the bipartisan manner in which it has been done.

Secondly, look at the amount of cooperation and coordination among the central government and the states.

If we can start doing things together, all the political parties at the Centre, and the central and state governments together, that is a message. So, that is a big takeaway from the whole macro side.

The market is discounting the full benefits of GST today itself. Look at the stock price reaction post GST.

Automobile stocks are up significantly and it is a fairly competitive sector, two-wheelers specially. First of all you don’t even know what the rates are to start with and it is assumed that company will capture all the earnings.

Somewhere the market has assumed the full benefits of GST, when its implementation looks like it is not happening or very tough in April 2017.

Sanjay Mookim
Director, Global Research, DSP-Merrill Lynch

It is a global equity rally and you can’t predict the time when the tide will flow up. Our recommendation is simple — avoid
illiquidity. Don’t buy small-, mid-cap stocks which are at all-time highs. Stick with companies unlikely to deliver operational disappointments. When I say markets are expensive, I am in effect recommending people to buy expensive stocks.

At this price, disappointment is punished severely. We have seen that in the results season for many quarters now. You do not want to buy a big hope of recovery. You are better off staying with steady performers.Double-digit earnings growth is a low bar and is probably in the price now.If you don’t get double-digit, there is something wrong. I argue that you should look at the index exbanks.

If you include banks, you are not interpreting earnings properly. The trend of the markets lags the economic cycle. It’s only when you get persistent performance that you can create a trend in equity prices. Unless you start seeing consistent earnings performance, which we haven’t seen so far, it is very difficult to sustain an upward trend.

The MSCI India PE has gone up from 12x to 15x over the last four years and it has gone up with increased dividend payouts. This is a phenomena in the US, where corporates are paying more and more dividends.

That has helped equity indices rise and that is exactly what has happened in India. Sectors such as IT, consumer have been paying more and more dividends and that seems to have allowed the market to rerate. If you look at the dividend yield chart of MSCI India, it is surprisingly flat. The volatility that you had in that metric has disappeared. Foreign investors are trading India as an absolute yield market for a very long period of time. What does that mean? Now, you can get higher from here if companies start paying more or you get earnings growth, which still remains a hope.

Click Here for Original Source – Economic Times

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