InvestmentsAug 9 2016

Managers expect short-term pain from Indian tax reform

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Managers expect short-term pain from Indian tax reform

Fund managers are expecting short-term pain in return for long-term gains in India after the country announced a landmark tax reform programme.

Last week the upper house in India’s national parliament approved a reformed goods and sales tax, a long-awaited move that will combine a variety of state and local indirect levies and charges into a single tax.

The harmonisation, a key part of prime minister Narendra Modi’s tax simplification plans, could increase cross-state trading and reduce costs for businesses, as well as increasing national tax receipts.

However, the tax still has to be individually approved by India’s 29 states. Baillie Gifford’s Ewan Markson-Brown, manager of the Pacific Horizon Investment Trust, said logistical demands could cause an economic slowdown in the interim.

“Changes of this magnitude have historically led to near-term slowdowns in economic activity and we would expect that this will hurt growth as companies adapt to the new regulations,” Mr Markson-Brown said.

“The [tax] still needs to be approved by the states. The final charges have not yet been determined and there are likely to be other issues in its implementation that will delay it beyond the currently expected one-year timeline.”

Similar concerns were expressed by Dhawal Mehta, senior India analyst at Somerset Capital Management. “With any major change there’s always an adjustment period,” he said.

India’s current growth rate suggests it has room for manoeuvre. Its economy expanded by 7.6 per cent in the 2015-16 financial year, up from 7.2 per cent in the previous year.

Economists have suggested the greater ease of trading and reduction in bureaucracy could increase annual GDP growth by 2 percentage points over the long term.

A shorter-term impact may be to renew investors’ faith in Mr Modi’s reforming agenda.

Despite Indian stocks outperforming emerging market peers comfortably on a three-year view, they have struggled since the summer of 2015 as doubts emerged over the extent to which the prime minister could improve the country’s investment case.

The MSCI India index has gained just 0.25 per cent over one year in local currency terms, compared with 1.2 per cent for the broader emerging markets benchmark.

Mr Mehta said Indian markets would focus on the long-term effects of tax reform rather than the impact of a potential near-term slowdown.

“I would think that the market will look beyond whatever short-term issues there are [and] look at the long-term benefits. It gives a boost to the economy in a meaningful way,” he said.

JPMorgan Indian Investment Trust manager Rajendra Nair added: “Even though the implementation could be disruptive in the short term, we believe it will be a key positive in the long term.

“We expect car companies to be beneficiaries due to lower duties, and cement producers to gain from lower effective rates and savings in logistics costs.”