India's central bank just funded a $20 billion corporate tax cut in what appears to be the world's first case of MMT (lite).
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It had been a bad year for India, which until recently was the fastest growing economy in the world, surpassing even China: the world's 2nd most populous nations printed a Q1 GDP of 5.0% for fiscal q1 2019/20, as India's economic activity slowed to the lowest rate in 6 years, with Rabobank earlier this week noting that a rebound in growth to 6% seems likely given the substantial widening of India’s output gap. Yet one thing could spark such a bounce and "lift the spirits in the Indian economy" according to Rabo: a substantial stimulus package.
That's precisely what the Indian government unveiled overnight, when without warning it pulled a page right out of the Trump playbook, and in an effort to
boost stocks stimulate the economy, it announced a surprise $20 billion tax cut, bringing India's corporate tax rate to one of the lowest in Asia.
However, unlike Trump's tax cut, this one had a twist - it would be entire funded by the central bank's remittance of cash to the government.
Some background: according to the finance ministry, domestic companies will pay 22% tax on their income from April 1, 2019, down sharply from 30% previously. The effective rate, including all additional levies, will be 25.2% and applicable on companies that aren’t availing any incentives or exemptions.
It gets better: according Finance Minister Nirmala Sitharaman, new companies formed from Oct. 1 will attract 15% tax and an effective rate of 17.01%, Sitharaman said. That brings it to the same level as in Singapore, which has the second lowest corporate tax rate in Asia, next only to Hong Kong.
Needless to say, the stock market - the biggest beneficiary of such fiscal (and monetary) generosity - loved it, and India’s main equity index, the BSE Sensex, soared 5.3%, its biggest gain since the financial crisis, while the rupee rallied after the announcement. Sovereign bonds slumped as fiscal concerns came sharply back to the fore.
Of course, in a world scrambling for fiscal stimulus, India is hardly alone, and joins Indonesia in cutting tax on corporates as Asian economies compete with each other to attract companies looking for alternate manufacturing locations to escape disruptions from the U.S.-China trade war, according to Bloomberg.
Commenting on the fiscal stimulus, BBG India Economist Abhishek Gupta said "The tax cuts are likely to boost private investment and have the potential to attract much more foreign direct investment. Any fiscal slippage is likely to be limited in the near term, as stronger tax buoyancy will boost growth."
That said, the 1.45 trillion-rupee, or $20.5 billion revenue loss from the move will test Sitharaman’s goal of narrowing the fiscal gap to 3.3% of GDP this year despite a more than $24 billion windfall from the Reserve Bank of India.
In fact, one can argue that with the Bank of India indirectly financing a tax cut, India is effectively testing out MMT "for the people." Confirming just that was the commentary by Madhavi Arora, an economist with Edelweiss Securities Pvt. in Mumbai, who said that "we are in a state of coordinated policy response both by the government and the RBI,” adding that "despite possible fiscal slippage, the RBI would likely deliver further cuts and continue to focus on policy transmission of earlier cuts."
What was the finance minister's take on this dangerous development? Simple:
“We are conscious of the impact all this will have on our fiscal deficit,” she said according to Bloomberg, without elaborating.
Conscious... yet clearly ignoring the potential risk in a world in which virtually no government is willing to consider long-term fiscal stability if it means a modest economic rebound.
And speaking of, the government’s growth support measures, announced over the last one month, supplement what we previously reported was the RBI’s generous dose of monetary stimulus. Governor Shaktikanta Das, who called the tax cut a “bold move,” has led the rate-setting Monetary Policy Committee to deliver 110 basis points of easing this year, while signaling his readiness to do more amid stable inflation.
Needless to say, the immediate response to the MMT was positive, as bankers and automakers said the move will help companies increase investment in the economy, while the finmin said the shocking development would promote growth and investment, Sitharaman said, speaking from the western Indian city of Panaji.
Predictably, with MMT on deck, bonds were not happy, as it means a feedback loop whereby more and more debt has to be issued just to keep the pace of growth constant. Sure enough, the yield on the benchmark 10-year bond climbed 15 basis points to 6.79%, with Bloomberg not unsarcastically pointing out that "higher yields could make it tougher to rein in borrowing costs."
That's one way of putting it - another is that India has somehow become the gunniea pig for huge monetary experiments: whether it is the Nov 2016 cash elimination, or today's MMT test, one almost has the impression that recent BIS meetings at the Basel tower had a simple agenda: test out in India what will soon be practiced around the globe.
Until then, Indian policy makers will have to ensure that "companies can borrow at competitive rates and must improve demand for the goods firms produce, said R. Shankar Raman, chief financial officer at Larsen & Toubro Ltd., India’s biggest engineering conglomerate."
“All of these need to fall in place for the investment rationale to be valid for providers of capital,” Raman said in a text message. “In all, a good beginning, albeit a year late.”
For now, everyone is happy, and as Priyanka Kishore, head of India and south east Asia economics at Oxford Economics said, "The unexpected fiscal stimulus is positive for sentiment", but added that "Investors will watch closely on how the potential damage to the budget deficit is managed."
Indeed they will, because when it comes to terminal monetary and fiscal experiments, nothing beats MMT, and while the sugar high is great, the monetary and fiscal collapse that follows will hardly lead to the same delighted reactions.