Impact of GST Rate Cut on Foreign Institutional Flows
The recent reduction in the Goods and Services Tax (GST) rates, effective from September 22, has created a conducive environment for the return of foreign institutional investors to India. However, analysts caution that these investors will still consider factors such as the impact of US tariffs, valuations, and the lackluster corporate earnings growth in India before increasing their investments.
GST Regime Overhaul
- The GST changes represent the most significant overhaul since the system's introduction in 2017.
- The number of GST slabs has been reduced from four to two:
- 5% for essentials
- 18% for other goods
- A new 40% tax has been introduced for luxury and sin items.
Market Underperformance and Earnings Growth
The Indian market's recent underperformance is attributed to weak domestic growth, with earnings growing in single digits over the past five quarters. Analysts, such as those at HSBC, expect growth to accelerate from the third quarter of fiscal 2025-26 (Q3-FY26) onwards, with a projected earnings per share (EPS) growth of 14% year-on-year in 2026.
Foreign Portfolio Investor Activity
- Foreign portfolio investors (FPIs) have sold stocks worth Rs 1.42 trillion in 2025, including Rs 12,257 crore in the first four days of September 2025.
- G. Chokkalingam, head of Equinomics Research, anticipates a reversal of the FII outflow trend starting from October 2025.
Key Factors Influencing Investment
- The GST rate cut, a reduction in direct taxes (Budget 2025), a good monsoon, and its impact on inflation and interest rates are viewed as positive factors for attracting foreign investment.
- However, valuation concerns, with the Nifty price-to-earnings ratio at 21x one-year forward, remain a consideration compared to other markets like China.
- A potential rate cut by the US Fed could encourage more foreign investment in India.
Corporate Earnings Outlook
Pramod Gubbi from Marcellus Investment Managers highlights that the effect of the GST rate cut on boosting consumption is uncertain, as companies have not seen a significant demand response despite passing on input cost deflation. He suggests that base effects, cyclical recovery, and debt repayment by consumers could lead to an earnings recovery in the coming quarters.
