India needs impetus - tax and interest rate cuts to deliver it

India's growth was clearly disappointing in the first half of 2019. In the first quarter, gross domestic product (GDP) was only 5.8% up on the previous year's figure, and in the second quarter, despite all the more positive forecasts, only 5.0% (y/y). The country has thus returned its status as the fastest growing emerging market economy to China, which, despite the trade conflict with the US, still achieved growth of 6.4% in the first quarter and 6.2% in the second.

Both private consumption and corporate investment showed weakness in the first half of the year. While consumption was impaired primarily by liquidity and credit bottlenecks in the financial sector, investments suffered from high corporate taxes. After his re-election in May, Prime Minister Modi did not lower these taxes, as many had expected, but on the contrary increased them. But now, in response to weak growth, he has put together an expansive fiscal package designed to quickly eradicate his fiscal mistakes.

The recently announced reduction in corporate income tax for domestic firms from 30% to 22% is particularly striking. New start-up companies are to be charged only 15% corporate income tax. This should stimulate investment activity. At the same time, however, it should be noted that the majority of Indian companies are small and medium-sized firms and thus almost all are exempt from corporate income tax. The government's new tax policy is therefore likely to have a positive, but overall rather limited, macro-effect.

The central bank is playing a strong role in trying to dispel the reasons for the weak growth and confirmed its expansionary course on 4 October with the fifth interest rate cut this year. It is likely to continue its course as long as inflation remains as moderate as it has been recently. Due to the long reaction time to the new tax policy, we expect GDP growth for 2019 to remain at only 5.25% and do not expect it to accelerate to 6.5% until next year.

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